Sany Heavy Equipment International Holdings Company Limited's (HKG:631) Intrinsic Value Is Potentially 83% Above Its Share Price

Key Insights

• The projected fair value for Sany Heavy Equipment International Holdings is HK$16.50 based on 2 Stage Free Cash Flow to Equity
• Sany Heavy Equipment International Holdings' HK$9.00 share price signals that it might be 45% undervalued
• Our fair value estimate is 61% higher than Sany Heavy Equipment International Holdings' analyst price target of CN¥10.24

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Sany Heavy Equipment International Holdings Company Limited (HKG:631) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

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The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CN¥, Millions)	CN¥1.94b	CN¥2.48b	CN¥2.90b	CN¥3.27b	CN¥3.59b	CN¥3.86b	CN¥4.10b	CN¥4.31b	CN¥4.50b	CN¥4.68b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 16.86%	Est @ 12.65%	Est @ 9.70%	Est @ 7.63%	Est @ 6.19%	Est @ 5.18%	Est @ 4.47%	Est @ 3.98%
Present Value (CN¥, Millions) Discounted @ 9.8%	CN¥1.8k	CN¥2.1k	CN¥2.2k	CN¥2.2k	CN¥2.2k	CN¥2.2k	CN¥2.1k	CN¥2.0k	CN¥1.9k	CN¥1.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥21b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.8%) 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 9.8%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥4.7b× (1 + 2.8%) ÷ (9.8%– 2.8%) = CN¥69b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥69b÷ ( 1 + 9.8%)¹⁰= CN¥27b

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¥48b. 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$9.0, the company appears quite good value at a 45% 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Sany Heavy Equipment International Holdings 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 9.8%, which is based on a levered beta of 1.331. 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.

View our latest analysis for Sany Heavy Equipment International Holdings

SWOT Analysis for Sany Heavy Equipment International Holdings

Next Steps:

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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. What is the reason for the share price sitting below the intrinsic value? For Sany Heavy Equipment International Holdings, we've put together three relevant items you should look at:

1. Financial Health: Does 631 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 631'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.