Summary:
In this analysis, we will dive into the intrinsic value of Hua Hong Semiconductor Limited (HKG:1347) using the Discounted Cash Flow (DCF) model. By estimating future cash flows and discounting them to their present value, we can determine whether the company is undervalued or not. While the DCF model is a helpful guide, it should not be the sole factor in investment valuation. Let’s take a closer look at Hua Hong Semiconductor’s potential value.
Is Hua Hong Semiconductor Undervalued?
Using a 2-stage model, we divide the company’s cash flows into two periods: a higher growth phase and a lower growth phase. For the first ten years, we estimate the cash flows based on analyst estimates or extrapolated values. We account for the fact that growth tends to slow more in the early years than in later years. By discounting these future cash flows, we determine that the present value of the 10-year cash flow is approximately US$1.2 billion.
Calculating Terminal Value:
To account for cash flows beyond the ten-year period, we calculate the Terminal Value using the Gordon Growth formula. This formula takes into consideration the future annual growth rate, which is estimated to be the 5-year average of the 10-year government bond yield of 2.0%. The Terminal Value is calculated to be approximately US$12 billion, and when discounted to today’s value, it amounts to approximately US$4.1 billion.
Evaluating the Equity Value:
The total equity value is obtained by summing the present value of the future cash flows and the present value of the Terminal Value. In this case, the equity value of Hua Hong Semiconductor is approximately US$5.4 billion. Dividing this value by the number of outstanding shares shows that compared to the current share price of HK$18.8, the company appears to be undervalued at a discount of 23%.
Considering Assumptions and Risks:
It is important to note that this valuation is based on certain assumptions, such as the discount rate and cash flows. Investors should reevaluate these inputs and consider the cyclicality of the industry and future capital requirements. Additionally, the DCF model does not account for debt, as it uses the cost of equity as the discount rate. Shareholders should also be aware of the company’s weaknesses, including declining earnings and dilution of shares.
Looking Ahead:
While the DCF calculation provides valuable insights, it should not be the sole factor for investment decision-making. Investors should consider various other factors and analysis methods to gain a comprehensive understanding of a company’s potential performance and value. By understanding the reasons why a company may be trading at a discount to its intrinsic value, investors can make more informed investment decisions.
The source of the article is from the blog elblog.pl