Is there a chance with the 36% undervaluation of OneConnect Financial Technology Co., Ltd. (NYSE: OCFT)?
In this article, we will explore the intrinsic value of OneConnect Financial Technology Co., Ltd. (NYSE: OCFT) estimate by taking expected future cash flows and discounting to today’s value. The discounted cash flow (DCF) model is the instrument that we will use for this. Don’t let the jargon put you off, the math behind it is actually pretty simple.
Remember, however, that there are many ways to appreciate a company’s value, and a DCF is only one way. If you would like to find out more about the discounted cash flow, you can read the background of this calculation in detail in the Simply Wall St analysis model.
Check out our latest analysis for OneConnect Financial Technology
Step by step through the calculation
We use the 2-step growth model, which simply means that we take into account two phases in the company’s growth. In the initial phase the company can show a higher growth rate and in the second phase a stable growth rate is normally assumed. First, we need to estimate the cash flows for the next ten years. We use analyst estimates wherever possible, but when these are not available we extrapolate the previous free cash flow (FCF) from the most recent estimate or reported value. We assume that companies with falling free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the first few years than in later years.
In general, we assume that a dollar today is more valuable than a dollar in the future, and the sum of those future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) forecast
|Levered FCF (CN ¥, million)||-CN ¥ 51.0m||CN ¥ 167.0m||CN ¥ 282.5m||CN ¥ 420.8m||CN ¥ 567.6m||CN ¥ 709.4m||CN ¥ 837.8 million||CN ¥ 948.8m||CN ¥ 1.04b||CN ¥ 1.12b|
|Source of growth rate estimate||Analyst x1||Analyst x1||Estimated @ 69.13%||Estimated @ 48.98%||Estimated @ 34.87%||Is @ 25%||East @ 18.09%||Estimate @ 13.25%||Estimated @ 9.86%||Estimate @ 7.49%|
|Present value (CN ¥, million) discounted @ 7.0%||-CN ¥ 47.7||CN ¥ 146||CN ¥ 230||CN ¥ 321||CN ¥ 404||CN ¥ 472||CN ¥ 521||CN ¥ 551||CN ¥ 566||CN ¥ 568|
(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = CN ¥ 3.7b
After calculating the present value of future cash flows in the first 10 year period, we need to calculate the terminal value that takes into account all future cash flows beyond the first tier. The Gordon Growth Formula is used to calculate the terminal value using a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today’s value with a cost of equity of 7.0%.
Final value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN ¥ 1.1b × (1 + 2.0%) ÷ (7.0% -2.0%) = CN ¥ 23b
Present value of the final value (PVTV)= TV / (1 + r) 10 = CN ¥ 23b ÷ (1 + 7.0%) 10 = CN ¥ 11b
The total value is the sum of the cash flows for the next ten years plus the discounted terminal value, giving the total equity value, which in this case is CN ¥ 15b. The final step is to divide the stock value by the number of shares outstanding. Compared to its current share price of $ 3.9, the company looks pretty undervalued at a 36% discount to the current share price. Ratings, however, are inaccurate instruments, much like a telescope – move a few degrees and land in a different galaxy. Keep this in mind.
NYSE: OCFT Discounted Cash Flow October 22, 2021
We point out that the most important input factors for a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree to these inputs, I recommend repeating the calculations yourself and playing with them. The DCF also does not take into account the possible cyclical nature of an industry or the future capital requirements of a company, so that it does not provide a complete picture of the potential performance of a company. Because we view OneConnect Financial Technology as a potential shareholder, the cost of equity is used as the discount rate rather than the cost of capital (or weighted average cost of capital, WACC) that accounts for debt. In this calculation we used 7.0% which is based on a debt beta of 1.020. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit between 0.8 and 2.0, which is a reasonable range for stable business.
While the DCF calculation is important, it ideally isn’t the only analysis you investigate for a company. The DCF model is not a perfect tool for stock valuation. The best thing to do is to apply different cases and assumptions and see how they affect the business valuation. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Why is the intrinsic value higher than the current share price? For OneConnect Financial Technology we have put together three relevant factors that you should consider:
- Risks: Every company has it and we discovered it 2 warning signs for OneConnect Financial Technology you should know.
- Future income: What is OCFT’s growth rate compared to competitors and the broader market? Learn more about analyst consensus numbers for the years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of quality stocks to get an idea of what else you might be missing!
PS. The Simply Wall St app performs a discounted cash flow rating for every stock on the NYSE on a daily basis. If you want to find the calculation for other stocks, just search here.
This article from Simply Wall St is of a general nature. We only provide comments based on historical data and analyst projections using an unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamentals. Note that our analysis may not take into account the latest company announcements or quality material, which may be sensitive to the price. Simply Wall St has no position in any of the stocks mentioned.
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