Stock Analysis

Are Shenzhen Airport Co., Ltd. (SZSE:000089) Investors Paying Above The Intrinsic Value?

SZSE:000089
Source: Shutterstock

Key Insights

  • The projected fair value for Shenzhen Airport is CN¥5.10 based on 2 Stage Free Cash Flow to Equity
  • Shenzhen Airport is estimated to be 30% overvalued based on current share price of CN¥6.61
  • The CN¥7.91 analyst price target for 000089 is 55% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Shenzhen Airport Co., Ltd. (SZSE:000089) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

See our latest analysis for Shenzhen Airport

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. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (CN¥, Millions) CN¥1.24b CN¥1.17b CN¥1.14b CN¥1.13b CN¥1.13b CN¥1.15b CN¥1.16b CN¥1.19b CN¥1.21b CN¥1.24b
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -2.56% Est @ -0.92% Est @ 0.23% Est @ 1.03% Est @ 1.59% Est @ 1.98% Est @ 2.26% Est @ 2.45%
Present Value (CN¥, Millions) Discounted @ 13% CN¥1.1k CN¥924 CN¥799 CN¥703 CN¥625 CN¥561 CN¥506 CN¥458 CN¥416 CN¥378

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥6.5b

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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CN¥1.2b× (1 + 2.9%) ÷ (13%– 2.9%) = CN¥13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥13b÷ ( 1 + 13%)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¥10b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥6.6, the company appears slightly overvalued 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.

dcf
SZSE:000089 Discounted Cash Flow July 12th 2024

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 Shenzhen Airport 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 1.731. 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 Shenzhen Airport

Strength
  • Debt is well covered by cash flow.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Interest payments on debt are not well covered.
  • Dividend is low compared to the top 25% of dividend payers in the Infrastructure market.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
Threat
  • Annual earnings are forecast to grow slower than the Chinese market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price exceeding the intrinsic value? For Shenzhen Airport, we've put together three essential factors you should look at:

  1. Risks: Be aware that Shenzhen Airport is showing 2 warning signs in our investment analysis , you should know about...
  2. Future Earnings: How does 000089'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 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!

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.

New: Manage All Your Stock Portfolios in One Place

We've created the ultimate portfolio companion for stock investors, and it's free.

• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks

Try a Demo Portfolio for Free

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.