Is There An Opportunity With Nexteer Automotive Group Limited’s (HKG:1316) 34.7% Undervaluation?

Simply Wall St.

Sat, Sep 29, 2018, 7:57 PM

I am going to run you through how I calculated the intrinsic value of Nexteer Automotive Group Limited (HKG:1316) by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in September 2018 so be sure check out the updated calculation by following the link below.

View our latest analysis for Nexteer Automotive Group

What’s the value?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

	2019	2020	2021	2022	2023
Levered FCF ($, Millions)	$340.86	$423.43	$472.37	$526.97	$587.89
Source	Analyst x7	Analyst x7	Est @ 11.56%	Est @ 11.56%	Est @ 11.56%
Present Value Discounted @ 10.54%	$308.35	$346.52	$349.71	$352.93	$356.18

Present Value of 5-year Cash Flow (PVCF)= US$1.71b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.2%. We discount this to today’s value at a cost of equity of 10.5%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = US$587.9m × (1 + 2.2%) ÷ (10.5% – 2.2%) = US$7.21b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = US$7.21b ÷ ( 1 + 10.5%)⁵ = US$4.37b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$6.08b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value in the company’s reported currency of $2.43. However, 1316’s primary listing is in United States, and 1 share of 1316 in USD represents 7.825 ( USD/ HKD) share of SEHK:1316, so the intrinsic value per share in HKD is HK$18.99. Relative to the current share price of HK$12.4, the stock is quite good value at a 34.7% discount to what it is available for right now.

SEHK:1316 Intrinsic Value Export September 30th 18

Important assumptions

I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Nexteer Automotive Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.5%, which is based on a levered beta of 1.069. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 1316, I’ve compiled three important factors you should further research:

Financial Health: Does 1316 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.
Future Earnings: How does 1316’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 1316? 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 for every stock on the HKG every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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