In this article, we will estimate the intrinsic value of Xinyi Solar Holdings Limited (HKG: 968) by estimating the company’s future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for Xinyi Solar Holdings
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually, the first stage is higher growth, and the second stage is a lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (HK $, Millions)||HK $ 2.10 billion||HK $ 4.72 billion||HK $ 11.0 billion||HK $ 13.3 billion||HK $ 14.9 billion||HK $ 16.3 billion||HK $ 17.4 billion||HK $ 18.3 billion||HK $ 19.0 billion||HK $ 19.7 billion|
|Source of estimated growth rate||Analyst x7||Analyst x7||Analyst x2||Analyst x2||East @ 12.4%||Est @ 9.12%||Est @ 6.83%||East @ 5.22%||Is 4.1%||East @ 3.31%|
|Present value (HK $, Million) discounted at 7.2%||2.0k HK $||4.1k HK $||HK $ 9.0k||HK $ 10.1k||HK $ 10.6,000||HK $ 10.7,000||HK $ 10.7,000||HK $ 10.5,000||10.2,000 HK $||HK $ 9.9k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 88 billion HK $
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 government bond yield of 1.5%. We discount the terminal cash flows to their present value at a cost of equity of 7.2%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = HK $ 20 billion × (1 + 1.5%) ÷ (7.2% – 1.5%) = HK $ 352 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= HK $ 352b ÷ (1 + 7.2%)ten= HK $ 176 billion
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is HK $ 264 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of HK $ 16.0, the company looks fairly good value with a 46% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
We draw your attention to the fact 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 assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Xinyi Solar 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 takes into account debt. . In this calculation, we used 7.2%, which is based on a leveraged beta of 1.141. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
While a business valuation is important, ideally, it won’t be the only analysis you look at for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. Can we understand why the company trades at a discount to its intrinsic value? For Xinyi Solar Holdings, we’ve put together three relevant things you should consider:
- Risks: For example, we discovered 1 warning sign for Xinyi Solar Holdings which you should know before investing here.
- Future benefits: How does 968’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you might not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each SEHK share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St does not have any position in the mentioned stocks.
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