Using the 2 Stage Free Cash Flow to Equity, Guangdong Xinbao Electrical Appliances Holdings fair value estimate is CN¥29.00
Guangdong Xinbao Electrical Appliances Holdings is estimated to be 50% undervalued based on current share price of CN¥14.57
Our fair value estimate is 30% higher than Guangdong Xinbao Electrical Appliances Holdings' analyst price target of CN¥22.33
How far off is Guangdong Xinbao Electrical Appliances Holdings Co., Ltd (SZSE:002705) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Step By Step Through The Calculation
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.
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) estimate
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF (CN¥, Millions)
CN¥736.0m
CN¥1.45b
CN¥1.64b
CN¥1.79b
CN¥1.92b
CN¥2.03b
CN¥2.13b
CN¥2.23b
CN¥2.31b
CN¥2.40b
Growth Rate Estimate Source
Analyst x1
Analyst x1
Analyst x1
Est @ 9.01%
Est @ 7.17%
Est @ 5.89%
Est @ 4.99%
Est @ 4.37%
Est @ 3.93%
Est @ 3.62%
Present Value (CN¥, Millions) Discounted @ 10%
CN¥668
CN¥1.2k
CN¥1.2k
CN¥1.2k
CN¥1.2k
CN¥1.1k
CN¥1.1k
CN¥1.0k
CN¥973
CN¥916
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CN¥11b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 10%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥34b÷ ( 1 + 10%)10= CN¥13b
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¥24b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CN¥14.6, the company appears quite undervalued at a 50% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
SZSE:002705 Discounted Cash Flow June 21st 2024
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Guangdong Xinbao Electrical Appliances 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 10%, which is based on a levered beta of 1.279. 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 Guangdong Xinbao Electrical Appliances Holdings
Strength
Earnings growth over the past year exceeded its 5-year average.
Debt is not viewed as a risk.
Dividend is in the top 25% of dividend payers in the market.
Dividend information for 002705.
Weakness
Earnings growth over the past year underperformed the Consumer Durables industry.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Good value based on P/E ratio and estimated fair value.
Threat
Dividends are not covered by cash flow.
Annual earnings are forecast to grow slower than the Chinese market.
See 002705's dividend history.
Looking Ahead:
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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Guangdong Xinbao Electrical Appliances Holdings, we've put together three further factors you should further research:
Risks: Be aware that Guangdong Xinbao Electrical Appliances Holdings is showing 1 warning sign in our investment analysis , you should know about...
Future Earnings: How does 002705'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Chinese stock every day, so if you want to find the intrinsic value of any other stock just search here.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
