A Look At The Fair Value Of Burning Rock Biotech Limited (NASDAQ:BNR)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Burning Rock Biotech fair value estimate is US$1.94

• Burning Rock Biotech's US$2.23 share price indicates it is trading at similar levels as its fair value estimate

• The CN¥5.54 analyst price target for BNR is 185% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Burning Rock Biotech Limited (NASDAQ:BNR) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Burning Rock Biotech

Is Burning Rock Biotech Fairly Valued?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	-CN¥494.0m	-CN¥318.0m	-CN¥133.0m	-CN¥17.0m	CN¥46.0m	CN¥76.6m	CN¥112.7m	CN¥150.6m	CN¥187.1m	CN¥219.9m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ 66.48%	Est @ 47.17%	Est @ 33.65%	Est @ 24.19%	Est @ 17.57%
Present Value (CN¥, Millions) Discounted @ 7.8%	-CN¥458	-CN¥273	-CN¥106	-CN¥12.6	CN¥31.5	CN¥48.7	CN¥66.5	CN¥82.4	CN¥94.9	CN¥103

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = -CN¥423m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.8%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥220m× (1 + 2.1%) ÷ (7.8%– 2.1%) = CN¥3.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥3.9b÷ ( 1 + 7.8%)¹⁰= CN¥1.8b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥1.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$2.2, the company appears around fair value at the time of writing. 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.

dcf

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Burning Rock Biotech 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 7.8%, 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 Burning Rock Biotech

Strength

• Currently debt free.

Weakness

• No major weaknesses identified for BNR.

Opportunity

• Forecast to reduce losses next year.

• Good value based on P/S ratio compared to estimated Fair P/S ratio.

Threat

• Has less than 3 years of cash runway based on current free cash flow.

• Not expected to become profitable over the next 3 years.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Burning Rock Biotech, we've put together three further aspects you should look at:

1. Risks: We feel that you should assess the 1 warning sign for Burning Rock Biotech we've flagged before making an investment in the company.

2. Future Earnings: How does BNR'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.

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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGM every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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