A Look At The Fair Value Of Shandong High Speed Renewable Energy Group Limited (SZSE:000803)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Shandong High Speed Renewable Energy Group fair value estimate is CN¥4.12
• With CN¥4.52 share price, Shandong High Speed Renewable Energy Group appears to be trading close to its estimated fair value
• When compared to theindustry average discount of -694%, Shandong High Speed Renewable Energy Group's competitors seem to be trading at a greater premium to fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Shandong High Speed Renewable Energy Group Limited (SZSE:000803) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Shandong High Speed Renewable Energy Group

Crunching The Numbers

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥84.6m	CN¥117.2m	CN¥150.0m	CN¥180.6m	CN¥208.0m	CN¥231.9m	CN¥252.6m	CN¥270.7m	CN¥286.6m	CN¥300.9m
Growth Rate Estimate Source	Est @ 53.89%	Est @ 38.61%	Est @ 27.91%	Est @ 20.42%	Est @ 15.17%	Est @ 11.50%	Est @ 8.93%	Est @ 7.14%	Est @ 5.88%	Est @ 5.00%
Present Value (CN¥, Millions) Discounted @ 13%	CN¥74.9	CN¥92.0	CN¥104	CN¥111	CN¥113	CN¥112	CN¥108	CN¥103	CN¥96.2	CN¥89.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.0b

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 (2.9%) 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)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥301m× (1 + 2.9%) ÷ (13%– 2.9%) = CN¥3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥3.1b÷ ( 1 + 13%)¹⁰= CN¥926m

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¥1.9b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥4.5, the company appears around fair value at the time of writing. 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.

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 Shandong High Speed Renewable Energy 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 13%, which is based on a levered beta of 1.767. 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.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 Shandong High Speed Renewable Energy Group, there are three additional aspects you should assess:

1. Risks: For instance, we've identified 3 warning signs for Shandong High Speed Renewable Energy Group (1 doesn't sit too well with us) you should be aware of.
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. 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.

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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.