We take the expected future flows and reduce them to their current value. In this case, we use the DCF model. Don’t go for less that your full potential.
There are many ways in which we as a company can be valued, and like DCF, each technique has advantages and disadvantages in certain situations. If you want to know more about discount cash flow, the logic behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for China Petroleum and Chemical
Step by step in the calculation
We use the so-called 2-step model, which means we have two different stages of growth for the company’s cash flow. In general, the first stage is high growth and the second stage is low growth. To begin with, we need to anticipate cash flows over the next decade. We use analytical estimates as much as possible, but in the absence of these, we deduct the previous FFF from the previous estimate or recorded value. We anticipate that declining free cash flow slows down, and that free cash flow slows down, during this time. We do this to show that growth is slowing down in the first few years more than in the following years.
In general, we estimate that one dollar is worth more than one dollar in the future, so we will reduce the value of these future cash flows to their estimated value in today’s dollars:
10-year free cash flow (FCF) forecast
|Covered FFF (CN, Millions)||CN ¥ 45.3b||CN ¥ 59.1 b||CN ¥ 127.7 b||CN ¥ 60.0b||CN ¥ 32.4 b||CN ¥ 22.1 b||CN ¥ 17.3b||CN ¥ 14.7 b||CN ¥ 13.2 b||CN ¥ 12.4 b|
|Estimated source of growth rate||Analyst x4||Analyst x4||Analyst x2||Analyst x1||Estimated @ -46.06%||Estimated @ -31.79%||Estimated @ -21.81%||Estimated @ -14.82%||Estimated @ -9.93%||Estimated @ -6.51%|
|Current Price (CN ¥, Millions) Discounted @ 10%||CN ¥ 41.1 km||CN ¥ 48.8 km||CN ¥ 95.8 km||CN ¥ 40.9 km||CN ¥ 20.0 km||CN ¥ 12.4 km||CN ¥ 8.8 km||CN ¥ 6.8 km||CN ¥ 5.6 km||CN ¥ 4.7 km|
(“Est” = FCF growth rate estimated by Simply Wall St)
Current price of 10 years cash flow (PVCF) = CN ¥ 285 b
After calculating the current value of future cash flows in the first 10 years, we must calculate the terminal value for all future cash flows beyond the initial level. Gordon’s growth formula is used to calculate terminal value on the basis of 1.5% of the future annual growth rate of 5% average 10-year government bond production. We will reduce terminal cash flows to today’s value at 10% equity value.
Terminal Value (TV)= FCC2031 × (1 + g) ÷ (r – g) = CN ¥ 12b × (1 + 1.5%) ÷ (10% – 1.5%) = CN ¥ 146b
Current Terminal Value (PVTV)= TV / (1 + R)10= CN ¥ 146b ÷ (1 + 10%)10= CN ¥ 56 b
The total value for the next ten years is the sum of the cash flows and the reduced terminal value, which results in the total equity value, in this case CN ¥ 341b. In the final step, we divide the value of the equation by the number of shares remaining. Compared to the current stock price of $ 3.9, the company is looking at a reasonable price at the time of writing. Estimates in any calculation have a great impact on the evaluation, so it is better to see this as an approximate estimate, not until the last century.
We suggest that the most important inputs for a cash flow are the discount rate and, of course, the actual cash flows. You do not have to agree to these inputs, I recommend repeating the calculations yourself and playing with them. DCF also does not take into account the cyclicality of the industry, or the company’s future capital, so it does not give a complete picture of a company’s potential performance. Since we are looking at Chinese petroleum and chemicals as shareholders, the fair equity price will serve as a discount rather than the debt capital (or average capital value, WACC). We used 10% of this calculation, based on a fractional beta of 1,727. Beta is a measure of market volatility in general compared to the market. We get our beta from the industry average beta of international comparison companies, with a limit between 0.8 and 2.0, which is a reasonable range for stable business.
While important, DCF calculation is not the only analytical component that can be thoroughly tested for a company. The cost of investment in DCF models is not final and final. Instead, the best use of the DCF model is to test whether certain assumptions and concepts lead to a low estimate or oversimplification of the company. For example, changes in the company’s fair price or risk-free rate may have a significant impact on the review. For Chinese Petroleum and Chemical, we have compiled three more things you should do for further research:
- Accidents: We feel you need to review 1 Warning sign for China Petroleum and Chemical We suggest before you invest in the company.
- Future IncomeHow does the growth rate of 386 compare with its peers and the wider market? Connect with our free Analyst for Growth prospect and dive into the Analysis consensus number for years to come.
- Other high quality options: Do you like a good universal person? Browse our list of interactive high-end stocks to get an idea of what else you are missing!
P. The Simply Wall St app runs a discount on SEHK on a daily basis. If you would like to get the calculation for other shares, just click here.
This article is general in nature at Simply Wall St. We offer opinions based on historical data and analytical predictions using an impartial method and our articles are not intended as financial advice. It does not advise buying or selling any stock, and does not take into account your goals or financial situation. We aim to provide you with a long-term analysis based on basic data. Note that our analysis may not apply to new value-added company ads or quality materials. Simply put, Wall St has no place in the listed stocks.
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