Sinotrans Limited's (HKG:598) Intrinsic Value Is Potentially 95% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Sinotrans fair value estimate is HK$9.37
• Sinotrans is estimated to be 49% undervalued based on current share price of HK$4.80
• The CN¥4.89 analyst price target for 598 is 48% less than our estimate of fair value

How far off is Sinotrans Limited (HKG:598) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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The Model

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CN¥, Millions)	CN¥2.99b	CN¥3.29b	CN¥3.48b	CN¥3.64b	CN¥3.79b	CN¥3.94b	CN¥4.07b	CN¥4.21b	CN¥4.34b	CN¥4.47b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 5.59%	Est @ 4.76%	Est @ 4.18%	Est @ 3.77%	Est @ 3.49%	Est @ 3.29%	Est @ 3.15%	Est @ 3.05%
Present Value (CN¥, Millions) Discounted @ 8.5%	CN¥2.8k	CN¥2.8k	CN¥2.7k	CN¥2.6k	CN¥2.5k	CN¥2.4k	CN¥2.3k	CN¥2.2k	CN¥2.1k	CN¥2.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥24b

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 8.5%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥4.5b× (1 + 2.8%) ÷ (8.5%– 2.8%) = CN¥81b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥81b÷ ( 1 + 8.5%)¹⁰= CN¥36b

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¥60b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$4.8, the company appears quite undervalued at a 49% 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Sinotrans 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 8.5%, 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.

View our latest analysis for Sinotrans

SWOT Analysis for Sinotrans

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Sinotrans, we've compiled three important items you should further examine:

1. Risks: For example, we've discovered 2 warning signs for Sinotrans (1 is concerning!) that you should be aware of before investing here.
2. Future Earnings: How does 598'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.