Are Henan Pinggao Electric Co.,Ltd. (SHSE:600312) Investors Paying Above The Intrinsic Value?

Simply Wall St · 10/18 03:53

Key Insights

  • Henan Pinggao ElectricLtd's estimated fair value is CN¥14.98 based on 2 Stage Free Cash Flow to Equity
  • Current share price of CN¥19.50 suggests Henan Pinggao ElectricLtd is potentially 30% overvalued
  • Analyst price target for 600312 is CN¥22.20, which is 48% above our fair value estimate

In this article we are going to estimate the intrinsic value of Henan Pinggao Electric Co.,Ltd. (SHSE:600312) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 Henan Pinggao ElectricLtd

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, 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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (CN¥, Millions) CN¥1.31b CN¥1.18b CN¥2.48b CN¥1.87b CN¥1.55b CN¥1.37b CN¥1.28b CN¥1.23b CN¥1.20b CN¥1.20b
Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x1 Analyst x1 Est @ -17.18% Est @ -11.17% Est @ -6.96% Est @ -4.02% Est @ -1.96% Est @ -0.52%
Present Value (CN¥, Millions) Discounted @ 8.2% CN¥1.2k CN¥1.0k CN¥2.0k CN¥1.4k CN¥1.0k CN¥854 CN¥735 CN¥651 CN¥590 CN¥543

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥9.9b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (2.9%) 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 8.2%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CN¥1.2b× (1 + 2.9%) ÷ (8.2%– 2.9%) = CN¥23b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥23b÷ ( 1 + 8.2%)10= CN¥10b

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 CN¥20b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥19.5, the company appears reasonably expensive at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
SHSE:600312 Discounted Cash Flow October 18th 2024

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. 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 Henan Pinggao ElectricLtd 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 8.2%, which is based on a levered beta of 1.079. 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 Henan Pinggao ElectricLtd

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Electrical market.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual revenue is forecast to grow faster than the Chinese market.
Threat
  • Annual earnings are forecast to grow slower than the Chinese market.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price exceeding the intrinsic value? For Henan Pinggao ElectricLtd, we've put together three pertinent items you should further research:

  1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Henan Pinggao ElectricLtd .
  2. Future Earnings: How does 600312'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 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!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SHSE every day. If you want to find the calculation for other stocks just search here.