Does this valuation of Sany Heavy Equipment International Holdings Company Limited (HKG:631) mean that investors are paying too much?

Key findings

Today we will go through one way to estimate the intrinsic value of Sany Heavy Equipment International Holdings Company Limited (HKG:631) by taking the expected future cash flows and discounting them to their present value. To do this, we will use the Discounted Cash Flow (DCF) model. It doesn’t actually take too much to do, although it may seem quite complex.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. If you want to learn more about intrinsic value, you should check out Simply Wall St’s analysis model.

View our latest analysis for Sany Heavy Equipment International Holdings

The calculation

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally, the first stage is higher growth and the second stage is a lower growth period. First, we need to estimate the next ten years’ cash flows. Since we don’t have analyst estimates of free cash flow available, we extrapolated the previous free cash flow (FCF) from the company’s last reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today. Therefore, the sum of these future cash flows is discounted to today’s value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 5.6 billion CNY

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.2%. We discount the terminal cash flows to today’s value at a cost of equity of 9.4%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥1.0b × (1 + 2.2%) ÷ (9.4% – 2.2%) = CN¥15b

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= CN¥15b÷ ( 1 + 9.4 %)¹⁰= 6.1 billion CNY

The total value or equity value is then the sum of the present value of future cash flows, which in this case is CN¥12 billion. In the final step, we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$4.9, the company appears slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to consider this as a rough estimate that is not accurate to the last cent.

The assumptions

The above calculation heavily depends on two assumptions. The first is the discount rate and the other is the cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we are considering Sany Heavy Equipment International Holdings as prospective 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 takes debt into account. In this calculation, we have used 9.4% which is based on a levered beta of 1.280. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0 which is a reasonable range for a stable company.

SWOT Analysis for Sany Heavy Equipment International Holdings

Go on:

While a company’s valuation is important, it shouldn’t be the only metric you consider when researching a company. The DCF model is not a perfect stock valuation tool. It should be viewed more as a guide to “what assumptions need to hold 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 significantly, the outcome may look very different. Can we figure out why the company is trading at a premium to intrinsic value? For Sany Heavy Equipment International Holdings, we’ve compiled three relevant points for you to examine:

1. Risks: For example, we found 2 warning signs for Sany Heavy Equipment International Holdings that you should know before investing here.
2. Future income: How does 631’s growth rate compare to its peers and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS. The Simply Wall St app runs 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 Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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