Is There An Opportunity With Hyphens Pharma International Limited's (Catalist:1J5) 44% Undervaluation?

Key Insights

• The projected fair value for Hyphens Pharma International is S$0.50 based on Dividend Discount Model

• Hyphens Pharma International's S$0.28 share price signals that it might be 44% undervalued

• Peers of Hyphens Pharma International are currently trading on average at a 176% premium

Today we will run through one way of estimating the intrinsic value of Hyphens Pharma International Limited (Catalist:1J5) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Hyphens Pharma International

The Model

As Hyphens Pharma International operates in the pharmaceuticals sector, we need to calculate the intrinsic value slightly differently. Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used. This often underestimates the value of a stock, but it can still be good as a comparison to competitors. We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We then discount this figure to today's value at a cost of equity of 6.0%. Relative to the current share price of S$0.3, the company appears quite good value at a 44% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)

= S$0.02 / (6.0% – 2.0%)

= S$0.5

Important Assumptions

We would point out that 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 these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Hyphens Pharma International as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 6.0%, which is based on a levered beta of 0.800. Beta is a measure of a stock's volatility, compared to the market as a whole. 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 a stable business.

SWOT Analysis for Hyphens Pharma International

Strength

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings growth over the past year underperformed the Pharmaceuticals industry.

• Dividend is low compared to the top 25% of dividend payers in the Pharmaceuticals market.

Opportunity

• Annual earnings are forecast to grow faster than the Singaporean market.

• Trading below our estimate of fair value by more than 20%.

Threat

• No apparent threats visible for 1J5.

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Hyphens Pharma International, we've put together three relevant items you should assess:

1. Risks: Be aware that Hyphens Pharma International is showing 3 warning signs in our investment analysis , you should know about...

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 1J5's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every Singaporean stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.