A Look At The Fair Value Of Xingye Wulian Service Group Co. Ltd. (HKG:9916)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Xingye Wulian Service Group fair value estimate is HK$0.66
• Xingye Wulian Service Group's HK$0.57 share price indicates it is trading at similar levels as its fair value estimate

In this article we are going to estimate the intrinsic value of Xingye Wulian Service Group Co. Ltd. (HKG:9916) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

See our latest analysis for Xingye Wulian Service Group

Is Xingye Wulian Service Group Fairly Valued?

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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥21.0m	CN¥18.6m	CN¥17.2m	CN¥16.4m	CN¥16.0m	CN¥15.8m	CN¥15.7m	CN¥15.8m	CN¥16.0m	CN¥16.2m
Growth Rate Estimate Source	Est @ -17.33%	Est @ -11.52%	Est @ -7.45%	Est @ -4.60%	Est @ -2.61%	Est @ -1.22%	Est @ -0.24%	Est @ 0.44%	Est @ 0.92%	Est @ 1.26%
Present Value (CN¥, Millions) Discounted @ 8.0%	CN¥19.4	CN¥15.9	CN¥13.6	CN¥12.1	CN¥10.9	CN¥9.9	CN¥9.2	CN¥8.5	CN¥8.0	CN¥7.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥115m

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 (2.0%) 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 8.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥16m× (1 + 2.0%) ÷ (8.0%– 2.0%) = CN¥276m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥276m÷ ( 1 + 8.0%)¹⁰= CN¥128m

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¥243m. 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$0.6, the company appears about fair value at a 14% 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.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Xingye Wulian Service Group 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 8.0%, which is based on a levered beta of 1.060. 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 Xingye Wulian Service Group

Moving On:

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. It's not possible to obtain a foolproof valuation with a DCF model. 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 Xingye Wulian Service Group, there are three pertinent elements you should consider:

1. Risks: We feel that you should assess the 2 warning signs for Xingye Wulian Service Group we've flagged before making an investment in the company.
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. 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.