Are Investors Undervaluing Great Wall Motor Company Limited (HKG:2333) By 37%?

Key Insights

• The projected fair value for Great Wall Motor is HK$22.66 based on 2 Stage Free Cash Flow to Equity
• Great Wall Motor is estimated to be 37% undervalued based on current share price of HK$14.38
• Analyst price target for 2333 is CN¥20.37 which is 10% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Great Wall Motor Company Limited (HKG:2333) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Is Great Wall Motor Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CN¥, Millions)	CN¥23.4b	CN¥19.7b	CN¥17.7b	CN¥16.6b	CN¥16.0b	CN¥15.7b	CN¥15.7b	CN¥15.8b	CN¥16.0b	CN¥16.3b
Growth Rate Estimate Source	Analyst x4	Analyst x5	Est @ -10.17%	Est @ -6.27%	Est @ -3.54%	Est @ -1.64%	Est @ -0.30%	Est @ 0.64%	Est @ 1.29%	Est @ 1.75%
Present Value (CN¥, Millions) Discounted @ 11%	CN¥21.0k	CN¥15.9k	CN¥12.9k	CN¥10.9k	CN¥9.4k	CN¥8.4k	CN¥7.5k	CN¥6.8k	CN¥6.2k	CN¥5.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥105b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥16b× (1 + 2.8%) ÷ (11%– 2.8%) = CN¥201b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥201b÷ ( 1 + 11%)¹⁰= CN¥70b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥175b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$14.4, the company appears quite undervalued at a 37% 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.

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Great Wall Motor 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 11%, which is based on a levered beta of 1.580. 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.

See our latest analysis for Great Wall Motor

SWOT Analysis for Great Wall Motor

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Great Wall Motor, we've compiled three further aspects you should assess:

1. Risks: Take risks, for example - Great Wall Motor has 2 warning signs we think you should be aware of.
2. Future Earnings: How does 2333'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. Simply Wall St updates its DCF calculation for every Hong Kong 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.