Using the 2 Stage Free Cash Flow to Equity, Yongxing Special Materials TechnologyLtd fair value estimate is CN¥29.01
Current share price of CN¥37.00 suggests Yongxing Special Materials TechnologyLtd is potentially 28% overvalued
Analyst price target for 2756 is CN¥47.84, which is 65% above our fair value estimate
Does the June share price for Yongxing Special Materials Technology Co.,Ltd (SZSE:002756) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
The Method
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. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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 (CN¥, Millions)
CN¥1.05b
CN¥1.00b
CN¥1.43b
CN¥1.30b
CN¥1.23b
CN¥1.19b
CN¥1.17b
CN¥1.17b
CN¥1.18b
CN¥1.20b
Growth Rate Estimate Source
Analyst x1
Analyst x2
Analyst x1
Est @ -9.27%
Est @ -5.62%
Est @ -3.06%
Est @ -1.27%
Est @ -0.02%
Est @ 0.85%
Est @ 1.47%
Present Value (CN¥, Millions) Discounted @ 9.3%
CN¥962
CN¥841
CN¥1.1k
CN¥909
CN¥785
CN¥696
CN¥629
CN¥575
CN¥531
CN¥493
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CN¥7.5b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 9.3%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥19b÷ ( 1 + 9.3%)10= CN¥7.9b
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¥15b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥37.0, the company appears slightly overvalued at the time of writing. 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.
SZSE:002756 Discounted Cash Flow June 28th 2024
The 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 Yongxing Special Materials TechnologyLtd 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 9.3%, which is based on a levered beta of 1.138. 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 Yongxing Special Materials TechnologyLtd
Strength
Debt is not viewed as a risk.
Dividend is in the top 25% of dividend payers in the market.
Dividend information for 002756.
Weakness
Earnings declined over the past year.
Opportunity
Good value based on P/E ratio compared to estimated Fair P/E ratio.
Threat
Dividends are not covered by cash flow.
Annual earnings are forecast to decline for the next 3 years.
See 002756's dividend history.
Looking Ahead:
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. 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. Can we work out why the company is trading at a premium to intrinsic value? For Yongxing Special Materials TechnologyLtd, there are three fundamental elements you should look at:
Risks: We feel that you should assess the 4 warning signs for Yongxing Special Materials TechnologyLtd (2 are a bit unpleasant!) we've flagged before making an investment in the company.
Future Earnings: How does 002756'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 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 Chinese stock every day, so if you want to find the intrinsic value of any other stock just search here.
Have 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. Simply Wall St has no position in any stocks mentioned.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
