Are Investors Undervaluing China Resources Gas Group Limited (HKG:1193) By 47%?

Simply Wall St.01-30

Key Insights Using the 2 Stage Free Cash Flow to Equity, China Resources Gas Group fair value estimate is HK$44.38 Current share price of HK$23.45 suggests China Resources Gas Group is potentially ...

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Our analysis will employ the Discounted Cash Flow (DCF) model.  Believe it or not, it's not too difficult to follow, as you'll see from our example!  Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation.  For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.  See our latest analysis for China Resources Gas Group  Is China Resources Gas Group Fairly Valued?   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.  To start off with, we need to estimate the next ten years of cash flows.   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.   Generally we assume that a dollar today is more valuable than a dollar in the future,  so we discount the value of these future cash flows to their estimated value in today's dollars:  10-year free cash flow (FCF) estimate  2024 2025 2026 2027 2028 2029 2030 2031 2032 2033  Levered FCF (HK$, Millions)  HK$452.5m HK$4.04b HK$10.8b HK$8.37b HK$7.04b HK$6.30b HK$5.87b HK$5.63b HK$5.50b HK$5.44b Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Analyst x1 Est @ -15.88% Est @ -10.53% Est @ -6.78% Est @ -4.15% Est @ -2.32% Est @ -1.03%  Present Value (HK$, Millions) Discounted @ 6.7%  HK$424 HK$3.5k HK$8.9k HK$6.5k HK$5.1k HK$4.3k HK$3.7k HK$3.3k HK$3.1k HK$2.8k (\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = HK$42b We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period.  The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%. Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = HK$5.4b× (1 + 2.0%) ÷ (6.7%– 2.0%) = HK$117bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$117b÷ ( 1 + 6.7%)10= HK$61b The total value, or equity value, is then the sum of the present value of the future cash flows,  which in this case is HK$103b.  To get the intrinsic value per share, we divide this by the total number of shares outstanding.  Relative to the current share price of HK$23.5, the company appears   quite undervalued    at a 47% 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. SEHK:1193 Discounted Cash Flow January 30th 2024  The Assumptions  The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 China Resources Gas Group 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 6.7%, which is based on a levered beta of 0.803. 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 China Resources Gas GroupStrength Debt is not viewed as a risk. Dividends are covered by earnings and cash flows.  Dividend information for 1193. Weakness Earnings declined over the past year. Dividend is low compared to the top 25% of dividend payers in the Gas Utilities market.Opportunity Annual earnings are forecast to grow for the next 4 years. Trading below our estimate of fair value by more than 20%. Threat  Annual earnings are forecast to grow slower than the Hong Kong market.  What else are analysts forecasting for 1193?  Looking Ahead:  Whilst important, the DCF calculation  shouldn't be the only metric you look at when researching 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result.   Why is the intrinsic value higher than the current share price?   For China Resources Gas Group, there are three  essential  aspects  you should look at:   Risks: You should be aware of the 1 warning sign for China Resources Gas Group we've uncovered before considering an investment in the company.  Future Earnings: How does 1193'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 Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!   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.Valuation is complex, but we're helping make it simple.Find out whether China Resources Gas Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free AnalysisHave feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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. 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