Is There An Opportunity With Xiaomi Corporation’s (HKG:1810) 25.28% Undervaluation?

Simply Wall St.

Wed, Nov 21, 2018, 5:05 PM

Does the November share price for Xiaomi Corporation (HKG:1810) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by projecting its future cash flows and then discounting them to today’s value. I will be using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not November 2018 then I highly recommend you check out the latest calculation for Xiaomi by following the link below.

View our latest analysis for Xiaomi

The calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

	2019	2020	2021	2022	2023
Levered FCF (CN¥, Millions)	CN¥15.15k	CN¥20.85k	CN¥21.80k	CN¥24.62k	CN¥28.56k
Source	Analyst x9	Analyst x9	Analyst x4	Analyst x3	Est @ 16%, capped from 33.09%
Present Value Discounted @ 8.44%	CN¥13.97k	CN¥17.73k	CN¥17.10k	CN¥17.80k	CN¥19.04k

Present Value of 5-year Cash Flow (PVCF)= CN¥86b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.4%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = CN¥29b × (1 + 2.2%) ÷ (8.4% – 2.2%) = CN¥468b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = CN¥468b ÷ ( 1 + 8.4%)⁵ = CN¥312b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CN¥398b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of HK$19.86. Compared to the current share price of HK$14.84, the stock is about right, perhaps slightly undervalued at a 25% discount to what it is available for right now.

SEHK:1810 Intrinsic Value Export November 22nd 18

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Xiaomi as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.4%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 1810, I’ve put together three key aspects you should further examine:

Financial Health: Does 1810 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does 1810’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 1810? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every HK stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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