China Suntien Green Energy Corporation Limited (HKG:956) Shares Could Be 50% Below Their Intrinsic Value Estimate

Today we will run through one way of estimating the intrinsic value of China Suntien Green Energy Corporation Limited (HKG:956) by taking the forecast future cash flows of the company and discounting them back 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for China Suntien Green Energy

Step by step through the calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (CN¥, Millions)	-CN¥7.05b	CN¥537.3m	CN¥1.77b	CN¥3.11b	CN¥3.39b	CN¥3.60b	CN¥3.77b	CN¥3.91b	CN¥4.03b	CN¥4.13b
Growth Rate Estimate Source	Analyst x2	Analyst x4	Analyst x4	Analyst x2	Analyst x2	Est @ 6.07%	Est @ 4.7%	Est @ 3.75%	Est @ 3.08%	Est @ 2.61%
Present Value (CN¥, Millions) Discounted @ 12%	-CN¥6.3k	CN¥425	CN¥1.2k	CN¥1.9k	CN¥1.9k	CN¥1.8k	CN¥1.7k	CN¥1.5k	CN¥1.4k	CN¥1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥6.9b

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 (1.5%) 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 12%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = CN¥4.1b× (1 + 1.5%) ÷ (12%– 1.5%) = CN¥39b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥39b÷ ( 1 + 12%)¹⁰= CN¥12b

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¥19b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$3.0, the company appears quite undervalued at a 50% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important assumptions

Now 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 China Suntien Green Energy 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 12%, which is based on a levered beta of 1.734. 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:

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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For China Suntien Green Energy, there are three essential items you should look at:

1. Risks: You should be aware of the 4 warning signs for China Suntien Green Energy (1 shouldn't be ignored!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does 956'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 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. 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.
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