Calculating The Intrinsic Value Of CNOOC Energy Technology & Services Limited (SHSE:600968)

Key Insights

• The projected fair value for CNOOC Energy Technology & Services is CN¥3.95 based on 2 Stage Free Cash Flow to Equity
• CNOOC Energy Technology & Services' CN¥3.32 share price indicates it is trading at similar levels as its fair value estimate
• The average premium for CNOOC Energy Technology & Services' competitorsis currently 788%

Today we will run through one way of estimating the intrinsic value of CNOOC Energy Technology & Services Limited (SHSE:600968) by taking the forecast future cash flows of the company and discounting them back 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!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for CNOOC Energy Technology & Services

The Model

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥3.20b	CN¥3.24b	CN¥3.30b	CN¥3.37b	CN¥3.45b	CN¥3.54b	CN¥3.64b	CN¥3.74b	CN¥3.84b	CN¥3.95b
Growth Rate Estimate Source	Est @ 0.64%	Est @ 1.33%	Est @ 1.81%	Est @ 2.15%	Est @ 2.39%	Est @ 2.55%	Est @ 2.67%	Est @ 2.75%	Est @ 2.81%	Est @ 2.85%
Present Value (CN¥, Millions) Discounted @ 11%	CN¥2.9k	CN¥2.7k	CN¥2.4k	CN¥2.3k	CN¥2.1k	CN¥1.9k	CN¥1.8k	CN¥1.7k	CN¥1.6k	CN¥1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥21b

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 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥4.0b× (1 + 2.9%) ÷ (11%– 2.9%) = CN¥53b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥53b÷ ( 1 + 11%)¹⁰= CN¥19b

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¥40b. 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¥3.3, the company appears about fair value at a 16% discount to where the stock price trades currently. 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 CNOOC Energy Technology & Services 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 1.358. 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:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For CNOOC Energy Technology & Services, there are three essential elements you should further examine:

1. Risks: Take risks, for example - CNOOC Energy Technology & Services has 1 warning sign we think you should be aware of.
2. Future Earnings: How does 600968'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.

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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.