Calculating The Fair Value Of Sichuan Guangan Aaa Public Co.,Ltd (SHSE:600979)

Key Insights

• Sichuan Guangan Aaa PublicLtd's estimated fair value is CN¥2.76 based on 2 Stage Free Cash Flow to Equity
• Sichuan Guangan Aaa PublicLtd's CN¥3.25 share price indicates it is trading at similar levels as its fair value estimate
• When compared to theindustry average discount of -268%, Sichuan Guangan Aaa PublicLtd's competitors seem to be trading at a greater premium to fair value

In this article we are going to estimate the intrinsic value of Sichuan Guangan Aaa Public Co.,Ltd (SHSE:600979) by taking the expected future cash flows and discounting them to today's 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Sichuan Guangan Aaa PublicLtd

Step By Step Through The Calculation

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 start off with, we need to estimate 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥159.6m	CN¥156.2m	CN¥155.2m	CN¥155.8m	CN¥157.5m	CN¥160.1m	CN¥163.4m	CN¥167.1m	CN¥171.1m	CN¥175.5m
Growth Rate Estimate Source	Est @ -4.30%	Est @ -2.15%	Est @ -0.65%	Est @ 0.40%	Est @ 1.13%	Est @ 1.65%	Est @ 2.01%	Est @ 2.26%	Est @ 2.44%	Est @ 2.56%
Present Value (CN¥, Millions) Discounted @ 6.8%	CN¥149	CN¥137	CN¥127	CN¥120	CN¥113	CN¥108	CN¥103	CN¥98.4	CN¥94.4	CN¥90.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.1b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 6.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥176m× (1 + 2.9%) ÷ (6.8%– 2.9%) = CN¥4.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥4.5b÷ ( 1 + 6.8%)¹⁰= CN¥2.3b

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¥3.5b. 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 around fair value at the time of writing. 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 Sichuan Guangan Aaa PublicLtd 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 6.8%, which is based on a levered beta of 0.800. 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:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Sichuan Guangan Aaa PublicLtd, there are three fundamental aspects you should explore:

1. Risks: Be aware that Sichuan Guangan Aaa PublicLtd is showing 4 warning signs in our investment analysis , and 1 of those is concerning...
2. 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!
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. 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.