Shares of Semiconductor Manufacturing International Corporation (HKG:981) could be 35% below their intrinsic value estimate

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What is the distance between Semiconductor Manufacturing International Corporation (HKG:981) and its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the expected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. This may sound complicated, but it’s actually quite simple!

We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St Analysis Template.

Check out our latest analysis for Semiconductor Manufacturing International

Is Semiconductor Manufacturing International Fairly Valued?

We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:

Estimated free cash flow (FCF) over 10 years

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF ($, millions) -$1.66 billion -$644.2 million -$100.2 million $740.0 million $1.30 billion $1.77 billion $2.22 billion $2.63 billion $2.98 billion $3.27 billion
Growth rate estimate Source Analyst x9 Analyst x9 Analyst x4 Analyst x2 Analyst x2 Is at 35.89% Is at 25.57% Is at 18.34% Is at 13.28% Is at 9.74%
Present value (in millions of dollars) discounted at 8.0% -$1.5000 -552 USD -US$79.5 $543 $884 $1,100 $1,300 $1,400 $1.5k $1.5k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $6.1 billion

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.5%. We discount terminal cash flows to present value at a cost of equity of 8.0%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$3.3 billion × (1 + 1.5%) ÷ (8.0%–1.5%) = US$51 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= $51 billion ÷ (1 + 8.0%)ten= $23 billion

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $29 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of HK$18.8, the company looks quite undervalued at a 35% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

SEHK: 981 Discounted Cash Flow March 3, 2022

Important assumptions

We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Semiconductor Manufacturing International 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 takes debt into account. In this calculation, we used 8.0%, which is based on a leveraged beta of 1.327. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Look forward:

While a business valuation is important, it shouldn’t be the only metric to consider when researching a business. It is not possible to obtain an infallible valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. Why is intrinsic value higher than the current stock price? For Semiconductor Manufacturing International, we’ve compiled three essentials you should explore:

  1. Risks: Be aware that Semiconductor Manufacturing International shows 2 warning signs in our investment analysis you should know…
  2. Future earnings: How does 981’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every Hong Kong stock daily, so if you want to find the intrinsic value of any other stock, just search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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