Key Insights

• The projected fair value for Anhui Hengyuan Coal Industry and Electricity PowerLtd is CN¥13.18 based on Dividend Discount Model

• Current share price of CN¥12.07 suggests Anhui Hengyuan Coal Industry and Electricity PowerLtd is potentially trading close to its fair value

• The average premium for Anhui Hengyuan Coal Industry and Electricity PowerLtd's competitorsis currently 105%

In this article we are going to estimate the intrinsic value of Anhui Hengyuan Coal Industry and Electricity Power Co.,Ltd (SHSE:600971) by projecting its future cash flows and then discounting them to today's value.  We will take advantage of the Discounted Cash Flow (DCF) model for this purpose.  Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

What's The Estimated Valuation?

We have to calculate the value of Anhui Hengyuan Coal Industry and Electricity PowerLtd slightly differently to other stocks because it is a oil and gas company.  Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used.  This often underestimates the value of a stock, but it can still be good as a comparison to competitors.  The 'Gordon Growth Model' is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever.  The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.9%. We then discount this figure to today's value at a cost of equity of 11%.  Relative to the current share price of CN¥12.1, the company appears   about fair value    at a 8.4% 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.

Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)

= CN¥1.0 / (11% – 2.9%)

= CN¥13.2

SHSE:600971 Discounted Cash Flow March 22nd 2024

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 Hengyuan Coal Industry and Electricity PowerLtd 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 11%, which is based on a levered beta of 1.368. 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 Anhui Hengyuan Coal Industry and Electricity PowerLtd

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

• Dividend is in the top 25% of dividend payers in the market.

• Dividend information for 600971.

Weakness

• Earnings growth over the past year is below its 5-year average.

• What are analysts forecasting for 600971?

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

• Good value based on P/E ratio and estimated fair value.

Threat

• No apparent threats visible for 600971.

Next Steps:

Whilst important, the DCF calculation  shouldn't be the only metric you look at when researching a company.  The DCF model is not a perfect stock valuation tool.  Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation.  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.  For Anhui Hengyuan Coal Industry and Electricity PowerLtd, we've compiled three  fundamental  elements  you should look at:

1. Risks: We feel that you should assess the 1 warning sign for Anhui Hengyuan Coal Industry and Electricity PowerLtd we've flagged before making an investment in the company.

2. Future Earnings: How does 600971'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.

3. 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SHSE every day. If you want to find the calculation for other stocks 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.