An Intrinsic Calculation For Jiangsu Expressway Company Limited (HKG:177) Shows It’s 49.23% Undervalued

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Jiangsu Expressway Company Limited (HKG:177) as an investment opportunity by projecting its future cash flows and then discounting them to today’s value. I will be using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in July 2018 so be sure check out the updated calculation by following the link below.

See our latest analysis for Jiangsu Expressway

The calculation

I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. The sum of these cash flows is then discounted to today’s value.

5-year cash flow estimate

2018 2019 2020 2021 2022
Levered FCF (CN¥, Millions) CN¥-2.24k CN¥1.52k CN¥6.17k CN¥6.48k CN¥6.82k
Source Analyst x1 Analyst x2 Analyst x1 Extrapolated @ (5.12%) Extrapolated @ (5.12%)
Present Value Discounted @ 8.92% CN¥-2.05k CN¥1.28k CN¥4.77k CN¥4.61k CN¥4.45k

Present Value of 5-year Cash Flow (PVCF)= CN¥13.05b

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.2%. We discount this to today’s value at a cost of equity of 8.9%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CN¥6.82b × (1 + 2.2%) ÷ (8.9% – 2.2%) = CN¥103.68b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CN¥103.68b ÷ ( 1 + 8.9%)5 = CN¥67.63b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥80.68b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value in the company’s reported currency of CN¥16.02. However, 177’s primary listing is in China, and 1 share of 177 in CNY represents 1.168 ( CNY/ HKD) share of OTCPK:JEXY.Y, so the intrinsic value per share in HKD is HK$18.71. Relative to the current share price of HK$9.5, the stock is quite good value at a 49.23% discount to what it is available for right now.

SEHK:177 Intrinsic Value Export July 20th 18
SEHK:177 Intrinsic Value Export July 20th 18

Important assumptions

Now 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Jiangsu Expressway as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.9%, which is based on a levered beta of 0.862. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 177, I’ve compiled three fundamental factors you should further research:

  1. Financial Health: Does 177 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does 177’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: Are there other high quality stocks you could be holding instead of 177? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every HK stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.