A Look At The Fair Value Of Dezhou United Petroleum Technology Co.,Ltd. (SZSE:301158)

Key Insights

• The projected fair value for Dezhou United Petroleum TechnologyLtd is CN¥12.21 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥11.23 suggests Dezhou United Petroleum TechnologyLtd is potentially trading close to its fair value
• The average premium for Dezhou United Petroleum TechnologyLtd's competitorsis currently 249%

How far off is Dezhou United Petroleum Technology Co.,Ltd. (SZSE:301158) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Dezhou United Petroleum TechnologyLtd

Step By Step Through 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥78.4m	CN¥91.9m	CN¥103.8m	CN¥114.1m	CN¥122.9m	CN¥130.7m	CN¥137.6m	CN¥143.8m	CN¥149.6m	CN¥155.1m
Growth Rate Estimate Source	Est @ 23.37%	Est @ 17.22%	Est @ 12.91%	Est @ 9.89%	Est @ 7.78%	Est @ 6.30%	Est @ 5.26%	Est @ 4.54%	Est @ 4.03%	Est @ 3.68%
Present Value (CN¥, Millions) Discounted @ 9.1%	CN¥71.9	CN¥77.2	CN¥79.9	CN¥80.5	CN¥79.5	CN¥77.5	CN¥74.8	CN¥71.7	CN¥68.3	CN¥64.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥746m

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 9.1%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥155m× (1 + 2.9%) ÷ (9.1%– 2.9%) = CN¥2.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥2.6b÷ ( 1 + 9.1%)¹⁰= CN¥1.1b

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¥1.8b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥11.2, the company appears about fair value at a 8.0% 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.

Important 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. 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 Dezhou United Petroleum TechnologyLtd 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 9.1%, which is based on a levered beta of 1.255. 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 Dezhou United Petroleum TechnologyLtd

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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 Dezhou United Petroleum TechnologyLtd, there are three fundamental factors you should consider:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Dezhou United Petroleum TechnologyLtd , and understanding this should be part of your investment process.
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.