Using the 2 Stage Free Cash Flow to Equity, Jiangsu King's Luck Brewery Ltd fair value estimate is CN¥90.23
Jiangsu King's Luck Brewery Ltd is estimated to be 45% undervalued based on current share price of CN¥49.66
The CN¥53.65 analyst price target for 603369 is 41% less than our estimate of fair value
In this article we are going to estimate the intrinsic value of Jiangsu King's Luck Brewery Joint-Stock Co.,Ltd. (SHSE:603369) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
The Calculation
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.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (CN¥, Millions)
CN¥3.31b
CN¥3.82b
CN¥4.21b
CN¥4.54b
CN¥4.83b
CN¥5.08b
CN¥5.32b
CN¥5.53b
CN¥5.73b
CN¥5.93b
Growth Rate Estimate Source
Analyst x2
Analyst x2
Est @ 10.08%
Est @ 7.90%
Est @ 6.37%
Est @ 5.30%
Est @ 4.55%
Est @ 4.02%
Est @ 3.66%
Est @ 3.40%
Present Value (CN¥, Millions) Discounted @ 6.8%
CN¥3.1k
CN¥3.4k
CN¥3.5k
CN¥3.5k
CN¥3.5k
CN¥3.4k
CN¥3.4k
CN¥3.3k
CN¥3.2k
CN¥3.1k
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CN¥33b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.8%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥153b÷ ( 1 + 6.8%)10= CN¥79b
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¥113b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥49.7, the company appears quite undervalued at a 45% 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.
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 Jiangsu King's Luck Brewery Ltd 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 6.8%, which is based on a levered beta of 0.800. 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 Jiangsu King's Luck Brewery Ltd
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Balance sheet summary for 603369.
Weakness
Earnings growth over the past year is below its 5-year average.
Dividend is low compared to the top 25% of dividend payers in the Beverage market.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Good value based on P/E ratio and estimated fair value.
Threat
Dividends are not covered by cash flow.
Annual earnings are forecast to grow slower than the Chinese market.
See 603369's dividend history.
Looking Ahead:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Jiangsu King's Luck Brewery Ltd, we've compiled three fundamental factors you should further research:
Risks: For example, we've discovered 2 warning signs for Jiangsu King's Luck Brewery Ltd (1 is a bit unpleasant!) that you should be aware of before investing here.
Future Earnings: How does 603369'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. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value: