A Look At The Fair Value Of HUYA Inc. (NYSE:HUYA)

Key Insights

• The projected fair value for HUYA is US$4.08 based on 2 Stage Free Cash Flow to Equity

• HUYA's US$4.38 share price indicates it is trading at similar levels as its fair value estimate

• Analyst price target for HUYA is CN¥4.63, which is 14% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of HUYA Inc. (NYSE:HUYA) as an investment opportunity 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. There's really not all that much to it, even though it might appear quite complex.

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.

Check out our latest analysis for HUYA

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	-CN¥115.7m	CN¥362.8m	CN¥377.5m	CN¥403.8m	CN¥447.0m	CN¥472.0m	CN¥493.7m	CN¥513.0m	CN¥530.6m	CN¥547.0m
Growth Rate Estimate Source	Analyst x3	Analyst x5	Analyst x2	Analyst x2	Analyst x1	Est @ 5.59%	Est @ 4.60%	Est @ 3.91%	Est @ 3.42%	Est @ 3.08%
Present Value (CN¥, Millions) Discounted @ 8.2%	-CN¥107	CN¥310	CN¥298	CN¥294	CN¥301	CN¥294	CN¥284	CN¥273	CN¥260	CN¥248

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥2.5b

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 (2.3%) 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 8.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥547m× (1 + 2.3%) ÷ (8.2%– 2.3%) = CN¥9.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥9.4b÷ ( 1 + 8.2%)¹⁰= CN¥4.3b

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¥6.7b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$4.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 HUYA 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 8.2%, which is based on a levered beta of 1.054. 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 HUYA

Strength

• Currently debt free.

Weakness

• Expensive based on P/S ratio and estimated fair value.

Opportunity

• Expected to breakeven next year.

• Has sufficient cash runway for more than 3 years based on current free cash flows.

Threat

• No apparent threats visible for HUYA.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For HUYA, we've compiled three fundamental items you should consider:

1. Financial Health: Does HUYA 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.

2. Future Earnings: How does HUYA'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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