An Intrinsic Calculation For Semiconductor Manufacturing International Corporation (HKG:981) Suggests It's 38% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Semiconductor Manufacturing International fair value estimate is HK$28.35
• Semiconductor Manufacturing International's HK$17.62 share price signals that it might be 38% undervalued
• Analyst price target for 981 is US$18.64 which is 34% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Semiconductor Manufacturing International Corporation (HKG:981) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Semiconductor Manufacturing International

What's The Estimated Valuation?

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 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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	-US$3.83b	-US$1.56b	-US$417.9m	-US$1.57b	US$1.89b	US$2.80b	US$3.76b	US$4.68b	US$5.52b	US$6.25b
Growth Rate Estimate Source	Analyst x8	Analyst x9	Analyst x8	Analyst x1	Analyst x1	Est @ 48.05%	Est @ 34.28%	Est @ 24.64%	Est @ 17.89%	Est @ 13.17%
Present Value ($, Millions) Discounted @ 11%	-US$3.4k	-US$1.3k	-US$304	-US$1.0k	US$1.1k	US$1.5k	US$1.8k	US$2.0k	US$2.1k	US$2.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.6b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$6.2b× (1 + 2.2%) ÷ (11%– 2.2%) = US$70b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$70b÷ ( 1 + 11%)¹⁰= US$24b

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 US$29b. 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$17.6, the company appears quite good value at a 38% 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. 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 Semiconductor Manufacturing International 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 11%, which is based on a levered beta of 1.612. 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 Semiconductor Manufacturing International

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Semiconductor Manufacturing International, we've compiled three further factors you should further examine:

1. Risks: Every company has them, and we've spotted 2 warning signs for Semiconductor Manufacturing International (of which 1 is concerning!) you should know about.
2. Future Earnings: How does 981'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 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com