Jiangsu Expressway Company Limited's (HKG:177) Intrinsic Value Is Potentially 94% Above Its Share Price

Today we will run through one way of estimating the intrinsic value of Jiangsu Expressway Company Limited (HKG:177) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Jiangsu Expressway

What's the estimated valuation?

We're 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 a stable growth rate. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (CN¥, Millions)	-CN¥518.3m	CN¥6.17b	CN¥6.54b	CN¥6.84b	CN¥7.09b	CN¥7.31b	CN¥7.50b	CN¥7.67b	CN¥7.82b	CN¥7.97b
Growth Rate Estimate Source	Est @ 7.84%	Analyst x1	Est @ 5.94%	Est @ 4.61%	Est @ 3.68%	Est @ 3.03%	Est @ 2.57%	Est @ 2.25%	Est @ 2.03%	Est @ 1.87%
Present Value (CN¥, Millions) Discounted @ 9.5%	-CN¥473	CN¥5.1k	CN¥5.0k	CN¥4.8k	CN¥4.5k	CN¥4.2k	CN¥4.0k	CN¥3.7k	CN¥3.5k	CN¥3.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥37b

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 9.5%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = CN¥8.0b× (1 + 1.5%) ÷ (9.5%– 1.5%) = CN¥101b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥101b÷ ( 1 + 9.5%)¹⁰= CN¥41b

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¥78b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$9.5, the company appears quite good value at a 49% 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.

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 Jiangsu Expressway 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 9.5%, which is based on a levered beta of 1.280. 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.

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. 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 Jiangsu Expressway, we've compiled three fundamental aspects you should further examine:

1. Risks: For instance, we've identified 2 warning signs for Jiangsu Expressway (1 can't be ignored) you should be aware of.
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: 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. 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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