Calculating The Intrinsic Value Of Shengli Oil & Gas Pipe Holdings Limited (HKG:1080)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Shengli Oil & Gas Pipe Holdings fair value estimate is HK$0.074
• Current share price of HK$0.06 suggests Shengli Oil & Gas Pipe Holdings is potentially trading close to its fair value
• Peers of Shengli Oil & Gas Pipe Holdings are currently trading on average at a 28% premium

In this article we are going to estimate the intrinsic value of Shengli Oil & Gas Pipe Holdings Limited (HKG:1080) by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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 Shengli Oil & Gas Pipe Holdings

Is Shengli Oil & Gas Pipe Holdings Fairly Valued?

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.

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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥30.7m	CN¥32.1m	CN¥33.3m	CN¥34.3m	CN¥35.3m	CN¥36.2m	CN¥37.0m	CN¥37.8m	CN¥38.6m	CN¥39.4m
Growth Rate Estimate Source	Est @ 5.67%	Est @ 4.53%	Est @ 3.73%	Est @ 3.18%	Est @ 2.79%	Est @ 2.52%	Est @ 2.33%	Est @ 2.19%	Est @ 2.10%	Est @ 2.03%
Present Value (CN¥, Millions) Discounted @ 14%	CN¥26.9	CN¥24.7	CN¥22.4	CN¥20.3	CN¥18.3	CN¥16.5	CN¥14.8	CN¥13.2	CN¥11.9	CN¥10.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥179m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥39m× (1 + 1.9%) ÷ (14%– 1.9%) = CN¥331m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥331m÷ ( 1 + 14%)¹⁰= CN¥89m

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¥268m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.06, the company appears about fair value at a 19% 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 Shengli Oil & Gas Pipe 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 14%, which is based on a levered beta of 2.000. 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.

Looking Ahead:

Although the valuation of a company is important, 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Shengli Oil & Gas Pipe Holdings, we've put together three pertinent elements you should further examine:

1. Risks: Case in point, we've spotted 3 warning signs for Shengli Oil & Gas Pipe Holdings you should be aware of, and 2 of them are significant.
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 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. 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.

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.