Calculating The Intrinsic Value Of Bohai Leasing Co., Ltd. (SZSE:000415)

Key Insights

• Bohai Leasing's estimated fair value is CN¥3.77 based on 2 Stage Free Cash Flow to Equity
• Bohai Leasing's CN¥3.94 share price indicates it is trading at similar levels as its fair value estimate
• Bohai Leasing's peers seem to be trading at a higher premium to fair value based onthe industry average of -463%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Bohai Leasing Co., Ltd. (SZSE:000415) as an investment opportunity 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. It may sound complicated, but actually it is quite simple!

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.

View our latest analysis for Bohai Leasing

Crunching The Numbers

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. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥3.26b	CN¥2.90b	CN¥2.70b	CN¥2.59b	CN¥2.54b	CN¥2.53b	CN¥2.54b	CN¥2.57b	CN¥2.61b	CN¥2.67b
Growth Rate Estimate Source	Est @ -16.95%	Est @ -11.03%	Est @ -6.88%	Est @ -3.97%	Est @ -1.94%	Est @ -0.52%	Est @ 0.48%	Est @ 1.17%	Est @ 1.66%	Est @ 2.00%
Present Value (CN¥, Millions) Discounted @ 13%	CN¥2.9k	CN¥2.3k	CN¥1.9k	CN¥1.6k	CN¥1.4k	CN¥1.2k	CN¥1.1k	CN¥984	CN¥887	CN¥803

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥15b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥2.7b× (1 + 2.8%) ÷ (13%– 2.8%) = CN¥28b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥28b÷ ( 1 + 13%)¹⁰= CN¥8.3b

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¥23b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥3.9, the company appears around fair value at the time of writing. 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.

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Bohai Leasing 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 13%, which is based on a levered beta of 2.000. 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:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for 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 Bohai Leasing, we've put together three pertinent elements you should look at:

1. Risks: Be aware that Bohai Leasing is showing 3 warning signs in our investment analysis , and 1 of those is significant...
2. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SZSE every day. If you want to find the calculation for other stocks just search here.

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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.