In this article we are going to estimate the intrinsic value of Anhui Conch Cement Company Limited (HKG:914) by taking the foreast future cash flows of the company and discounting them back to today's value. I will use the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
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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. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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) forecast
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
Levered FCF (CN¥, Millions)
CN¥27.40k
CN¥26.09k
CN¥24.93k
CN¥24.29k
CN¥24.00k
CN¥23.94k
CN¥24.05k
CN¥24.26k
CN¥24.56k
CN¥24.92k
Growth Rate Estimate Source
Analyst x4
Analyst x4
Analyst x4
Est @ -2.57%
Est @ -1.2%
Est @ -0.24%
Est @ 0.43%
Est @ 0.9%
Est @ 1.23%
Est @ 1.46%
Present Value (CN¥, Millions) Discounted @ 7.69%
CN¥25.44k
CN¥22.50k
CN¥19.96k
CN¥18.06k
CN¥16.57k
CN¥15.35k
CN¥14.32k
CN¥13.41k
CN¥12.61k
CN¥11.88k
Present Value of 10-year Cash Flow (PVCF)= CN¥170.11b
"Est" = FCF growth rate estimated by Simply Wall St
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = CN¥CN¥447b ÷ ( 1 + 7.7%)10 = CN¥213.15b
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¥383.26b. The last step is to then 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¥72.32. However, 914’s primary listing is in China, and 1 share of 914 in CNY represents 1.138 ( CNY/ HKD) share of OTCPK:AHCH.F, so the intrinsic value per share in HKD is HK$82.27. Relative to the current share price of HK$44.3, the company appears quite good value at a 46% 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.
SEHK:914 Intrinsic value, May 28th 2019
The assumptions
Now 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 Anhui Conch Cement 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 7.7%, which is based on a levered beta of 0.954. 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:
Valuation is only one side of the coin in terms of building your investment thesis, and 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 Anhui Conch Cement, I've put together three essential factors you should look at:
Future Earnings: How does 914'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 914? 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 HKG every day. If you want to find the calculation for other stocks 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.
