Calculating The Fair Value Of Guangdong Shenglu Telecommunication Tech. Co., Ltd. (SZSE:002446)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Guangdong Shenglu Telecommunication Tech fair value estimate is CN¥6.35
• With CN¥6.11 share price, Guangdong Shenglu Telecommunication Tech appears to be trading close to its estimated fair value
• Guangdong Shenglu Telecommunication Tech's peers are currently trading at a premium of 396% on average

Does the May share price for Guangdong Shenglu Telecommunication Tech. Co., Ltd. (SZSE:002446) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. 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.

See our latest analysis for Guangdong Shenglu Telecommunication Tech

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥96.4m	CN¥145.1m	CN¥197.7m	CN¥249.5m	CN¥297.4m	CN¥340.0m	CN¥377.1m	CN¥409.1m	CN¥437.0m	CN¥461.7m
Growth Rate Estimate Source	Est @ 70.87%	Est @ 50.48%	Est @ 36.21%	Est @ 26.21%	Est @ 19.22%	Est @ 14.32%	Est @ 10.90%	Est @ 8.50%	Est @ 6.82%	Est @ 5.64%
Present Value (CN¥, Millions) Discounted @ 8.3%	CN¥89.1	CN¥124	CN¥156	CN¥181	CN¥200	CN¥211	CN¥216	CN¥217	CN¥214	CN¥208

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.8b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 8.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥462m× (1 + 2.9%) ÷ (8.3%– 2.9%) = CN¥8.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥8.8b÷ ( 1 + 8.3%)¹⁰= CN¥4.0b

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¥5.8b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥6.1, the company appears about fair value at a 3.7% discount to where the stock price trades currently. 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.

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. 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 Guangdong Shenglu Telecommunication Tech 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 8.3%, which is based on a levered beta of 0.956. 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 Guangdong Shenglu Telecommunication Tech

Looking Ahead:

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?" 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 Guangdong Shenglu Telecommunication Tech, there are three important aspects you should look at:

1. Risks: For instance, we've identified 3 warning signs for Guangdong Shenglu Telecommunication Tech that you should be aware of.
2. Future Earnings: How does 002446'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 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.