Key Insights
- Using the Dividend Discount Model, Sichuan Road & BridgeLtd fair value estimate is CN¥9.79
- With CN¥7.93 share price, Sichuan Road & BridgeLtd appears to be trading close to its estimated fair value
- Sichuan Road & BridgeLtd's peers are currently trading at a premium of 243% on average
Does the March share price for Sichuan Road & Bridge Co.,Ltd (SHSE:600039) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
The Calculation
We have to calculate the value of Sichuan Road & BridgeLtd slightly differently to other stocks because it is a construction company. Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock. We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained. For a number of reasons a very conservative growth rate is used that cannot exceed that of a company's Gross Domestic Product (GDP). In this case we used the 5-year average of the 10-year government bond yield (2.9%). The expected dividend per share is then discounted to today's value at a cost of equity of 9.6%. Relative to the current share price of CN¥7.9, the company appears about fair value at a 19% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)
= CN¥0.6 / (9.6% – 2.9%)
= CN¥9.8
Important 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 Sichuan Road & BridgeLtd 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 9.6%, which is based on a levered beta of 1.179. 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 Sichuan Road & BridgeLtd
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Dividend is in the top 25% of dividend payers in the market.
- Dividend information for 600039.
- Earnings growth over the past year is below its 5-year average.
- Annual revenue is forecast to grow faster than the Chinese market.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Dividends are not covered by cash flow.
- Is 600039 well equipped to handle threats?
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Sichuan Road & BridgeLtd, we've put together three fundamental aspects you should further research:
- Risks: As an example, we've found 2 warning signs for Sichuan Road & BridgeLtd (1 can't be ignored!) that you need to consider before investing here.
- Future Earnings: How does 600039'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.
- 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 Chinese stock every day, so if you want to find the intrinsic value of any other stock 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.