How far is China Energine International (Holdings) Limited (HKG:1185) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the expected future cash flows and discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to do, although it may seem quite complex.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
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Is China Energine International (Holdings) fair valued?
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To begin with, we need to obtain cash flow estimates for the next ten years. Since no analyst estimates of free cash flow are available to us, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF (HK$, Millions) | HK$18.3 million | HK$26.0 million | HK$33.8 million | HK$41.0 million | HK$47.4 million | HK$52.8 million | HK$57.2 million | HK$60.8 million | HK$63.9 million | HK$66.4 million |
Growth rate estimate Source | Is at 59.45% | Is at 42.1% | Is @ 29.96% | Is at 21.46% | Is at 15.51% | East @ 11.34% | Is at 8.42% | Is at 6.38% | Is at 4.95% | Is 3.95% |
Present value (HK$, millions) discounted at 5.9% | HK$17.3 | HK$23.2 | HK$28.4 | HK$32.6 | HK$35.6 | HK$37.4 | HK$38.3 | HK$38.5 | HK$38.1 | HK$37.4 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = HK$326 million
After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.6%. We discount terminal cash flows to present value at a cost of equity of 5.9%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = HK$66 million × (1 + 1.6%) ÷ (5.9%–1.6%) = HK$1.6 billion Kong
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= HK$1.6 billion÷ (1 + 5.9%)^{ten}= HK$891 million
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is HK$1.2 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of HK$0.2, the company appears to be about fair value at a 12% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
The hypotheses
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider China Energine International (Holdings) 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 takes into account the debt. In this calculation, we used 5.9%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Next steps:
Although a business valuation is important, it is only one of the many factors you need to assess for a business. The DCF model is not a perfect stock valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For China Energine International (Holdings), we have compiled three additional things for you to assess:
- Risks: Be aware that China Energine International (Holdings) displays 3 warning signs in our investment analysis and 2 of them are significant…
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
- Other top analyst picks: Interested to see what the analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think could have attractive future prospects!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock daily, so if you want to find the intrinsic value of any other stock, just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.