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Today we will run through one way of estimating the intrinsic value of Yangzijiang Shipbuilding (Holdings) Ltd. (SGX:BS6) by taking the expected future cash flows and discounting them to today's value. I will use the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
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 start off with, we need to estimate 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
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
Levered FCF (CN¥, Millions)
CN¥2.02k
CN¥2.77k
CN¥2.99k
CN¥3.18k
CN¥3.34k
CN¥3.48k
CN¥3.60k
CN¥3.72k
CN¥3.83k
CN¥3.94k
Growth Rate Estimate Source
Analyst x2
Analyst x4
Analyst x3
Est @ 6.2%
Est @ 5.03%
Est @ 4.21%
Est @ 3.64%
Est @ 3.24%
Est @ 2.96%
Est @ 2.76%
Present Value (CN¥, Millions) Discounted @ 9.05%
CN¥1.85k
CN¥2.33k
CN¥2.31k
CN¥2.25k
CN¥2.16k
CN¥2.07k
CN¥1.97k
CN¥1.86k
CN¥1.76k
CN¥1.66k
Present Value of 10-year Cash Flow (PVCF)= CN¥20.20b
"Est" = FCF growth rate estimated by Simply Wall St
After calculating the present value of future cash flows in the intial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 9%.
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = CN¥CN¥60b ÷ ( 1 + 9%)10 = CN¥25.11b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥45.32b. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate in the company’s reported currency of CN¥11.48. However, BS6’s primary listing is in China, and 1 share of BS6 in CNY represents 0.197 ( CNY/ SGD) share of SGX:BS6, so the intrinsic value per share in SGD is SGD2.26. Compared to the current share price of SGD1.53, the company appears quite undervalued at a 32% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
SGX:BS6 Intrinsic value, June 30th 2019
The assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Yangzijiang Shipbuilding (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 accounts for debt. In this calculation we've used 9%, which is based on a levered beta of 1.132. 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.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price to differ from the intrinsic value? For Yangzijiang Shipbuilding (Holdings), I've compiled three fundamental factors you should look at:
Future Earnings: How does BS6'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.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of BS6? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every SG stock every day, so if you want to find the intrinsic value of any other stock just search here.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
