Estimating The Intrinsic Value Of Shanghai XNG Holdings Limited (HKG:3666)

Key Insights

• Shanghai XNG Holdings' estimated fair value is CN¥0.09 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥0.08 suggests Shanghai XNG Holdings is trading close to its fair value

In this article we are going to estimate the intrinsic value of Shanghai XNG Holdings Limited (HKG:3666) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Shanghai XNG Holdings

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥37.3m	CN¥28.0m	CN¥23.2m	CN¥20.6m	CN¥19.0m	CN¥18.1m	CN¥17.6m	CN¥17.3m	CN¥17.2m	CN¥17.2m
Growth Rate Estimate Source	Est @ -36.47%	Est @ -25.04%	Est @ -17.04%	Est @ -11.44%	Est @ -7.52%	Est @ -4.78%	Est @ -2.86%	Est @ -1.52%	Est @ -0.58%	Est @ 0.08%
Present Value (CN¥, Millions) Discounted @ 13%	CN¥32.9	CN¥21.8	CN¥15.9	CN¥12.4	CN¥10.1	CN¥8.5	CN¥7.3	CN¥6.3	CN¥5.6	CN¥4.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥126m

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 (1.6%) 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 13%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥17m× (1 + 1.6%) ÷ (13%– 1.6%) = CN¥149m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥149m÷ ( 1 + 13%)¹⁰= CN¥42m

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¥168m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$0.08, the company appears about fair value at a 12% 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. 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 Shanghai XNG Holdings 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 1.817. 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 Shanghai XNG Holdings

Next Steps:

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. DCF models are not the be-all and end-all of investment valuation. 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. 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 Shanghai XNG Holdings, we've compiled three further elements you should further examine:

1. Risks: To that end, you should learn about the 4 warning signs we've spotted with Shanghai XNG Holdings (including 3 which are potentially serious) .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 3666's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 SEHK 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.