Is Anhui Conch Cement Company Limited (HKG:914) Trading At A 37% Discount?

By
Simply Wall St
Published
November 18, 2021
SEHK:914
Source: Shutterstock

Does the November share price for Anhui Conch Cement Company Limited (HKG:914) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

Check out our latest analysis for Anhui Conch Cement

The model

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. 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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (CN¥, Millions) CN¥25.5b CN¥26.2b CN¥13.9b CN¥12.3b CN¥11.4b CN¥10.9b CN¥10.6b CN¥10.4b CN¥10.4b CN¥10.4b
Growth Rate Estimate Source Analyst x5 Analyst x5 Analyst x1 Analyst x1 Est @ -7.27% Est @ -4.64% Est @ -2.81% Est @ -1.52% Est @ -0.62% Est @ 0.01%
Present Value (CN¥, Millions) Discounted @ 5.6% CN¥24.1k CN¥23.5k CN¥11.8k CN¥9.9k CN¥8.7k CN¥7.9k CN¥7.2k CN¥6.7k CN¥6.3k CN¥6.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥112b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 5.6%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥10b× (1 + 1.5%) ÷ (5.6%– 1.5%) = CN¥254b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥254b÷ ( 1 + 5.6%)10= CN¥147b

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¥260b. 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$37.6, the company appears quite undervalued at a 37% 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.

dcf
SEHK:914 Discounted Cash Flow November 19th 2021

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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Anhui Conch Cement 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 5.6%, which is based on a levered beta of 0.833. 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:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 Anhui Conch Cement, there are three relevant items you should consider:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Anhui Conch Cement (at least 1 which is potentially serious) , and understanding them should be part of your investment process.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 914's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.

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