Stock Analysis

# Calculating The Intrinsic Value Of Datang International Power Generation Co., Ltd. (HKG:991)

Does the December share price for Datang International Power Generation Co., Ltd. (HKG:991) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Datang International Power Generation

### The method

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 begin with, we have to get estimates of 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.

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) estimate

 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Levered FCF (CN¥, Millions) CN¥3.61b CN¥2.49b CN¥1.96b CN¥1.68b CN¥1.52b CN¥1.42b CN¥1.37b CN¥1.34b CN¥1.32b CN¥1.32b Growth Rate Estimate Source Est @ -44.76% Est @ -30.89% Est @ -21.18% Est @ -14.38% Est @ -9.62% Est @ -6.29% Est @ -3.96% Est @ -2.33% Est @ -1.19% Est @ -0.39% Present Value (CN¥, Millions) Discounted @ 8.4% CN¥3.3k CN¥2.1k CN¥1.5k CN¥1.2k CN¥1.0k CN¥877 CN¥777 CN¥700 CN¥638 CN¥586

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥13b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 8.4%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥1.3b× (1 + 1.5%) ÷ (8.4%– 1.5%) = CN¥19b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥19b÷ ( 1 + 8.4%)10= CN¥8.6b

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¥21b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK\$1.7, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

### The 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 Datang International Power Generation 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 8.4%, which is based on a levered beta of 1.396. 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.

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. 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 Datang International Power Generation, we've compiled three additional aspects you should explore:

1. Risks: You should be aware of the 5 warning signs for Datang International Power Generation (1 is potentially serious!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does 991'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. 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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