Calculating The Fair Value Of Shanghai National Center of Testing and Inspection for Electric Cable and Wire Co., Ltd. (SZSE:301289)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Shanghai National Center of Testing and Inspection for Electric Cable and Wire fair value estimate is CN¥36.14
• Shanghai National Center of Testing and Inspection for Electric Cable and Wire's CN¥40.62 share price indicates it is trading at similar levels as its fair value estimate
• Industry average of 3,549% suggests Shanghai National Center of Testing and Inspection for Electric Cable and Wire's peers are currently trading at a higher premium to fair value

Today we will run through one way of estimating the intrinsic value of Shanghai National Center of Testing and Inspection for Electric Cable and Wire Co., Ltd. (SZSE:301289) 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

Check out our latest analysis for Shanghai National Center of Testing and Inspection for Electric Cable and Wire

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 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.

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¥105.3m	CN¥119.5m	CN¥131.7m	CN¥142.4m	CN¥151.7m	CN¥159.9m	CN¥167.5m	CN¥174.5m	CN¥181.1m	CN¥187.5m
Growth Rate Estimate Source	Est @ 17.90%	Est @ 13.41%	Est @ 10.27%	Est @ 8.07%	Est @ 6.53%	Est @ 5.45%	Est @ 4.70%	Est @ 4.17%	Est @ 3.80%	Est @ 3.54%
Present Value (CN¥, Millions) Discounted @ 7.9%	CN¥97.6	CN¥103	CN¥105	CN¥105	CN¥104	CN¥101	CN¥98.5	CN¥95.1	CN¥91.5	CN¥87.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥989m

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 7.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥188m× (1 + 2.9%) ÷ (7.9%– 2.9%) = CN¥3.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥3.9b÷ ( 1 + 7.9%)¹⁰= CN¥1.8b

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¥2.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CN¥40.6, 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.

Important 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 Shanghai National Center of Testing and Inspection for Electric Cable and Wire 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 7.9%, which is based on a levered beta of 0.877. 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:

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. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Shanghai National Center of Testing and Inspection for Electric Cable and Wire, we've put together three pertinent factors you should assess:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Shanghai National Center of Testing and Inspection for Electric Cable and Wire .
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 Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.