Key Insights
- China Longyuan Power Group's estimated fair value is HK$5.91 based on Dividend Discount Model
- Current share price of HK$6.59 suggests China Longyuan Power Group is potentially trading close to its fair value
- Our fair value estimate is 29% lower than China Longyuan Power Group's analyst price target of CN¥8.26
Today we will run through one way of estimating the intrinsic value of China Longyuan Power Group Corporation Limited (HKG:916) by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Is China Longyuan Power Group Fairly Valued?
As China Longyuan Power Group operates in the renewable energy sector, we need to calculate the intrinsic value slightly differently. 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 2.3%. We then discount this figure to today's value at a cost of equity of 7.2%. Compared to the current share price of HK$6.6, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)
= CN¥0.3 / (7.2% – 2.3%)
= HK$5.9
Important 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 China Longyuan Power Group 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 7.2%, which is based on a levered beta of 0.982. 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 China Longyuan Power Group
- Debt is well covered by earnings.
- Balance sheet summary for 916.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Renewable Energy market.
- Annual earnings are forecast to grow faster than the Hong Kong market.
- Good value based on P/E ratio compared to estimated Fair P/E ratio.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company has no free cash flows.
- Revenue is forecast to grow slower than 20% per year.
- Is 916 well equipped to handle threats?
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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For China Longyuan Power Group, we've put together three further elements you should further examine:
- Risks: Case in point, we've spotted 3 warning signs for China Longyuan Power Group you should be aware of, and 1 of them shouldn't be ignored.
- Future Earnings: How does 916'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK 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.
