Using the 2 Stage Free Cash Flow to Equity, Anhui Zhongding Sealing Parts fair value estimate is CN¥16.94
Current share price of CN¥13.15 suggests Anhui Zhongding Sealing Parts is potentially 22% undervalued
The CN¥15.18 analyst price target for 887 is 10% less than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Anhui Zhongding Sealing Parts Co., Ltd. (SZSE:000887) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.
Step By Step Through The Calculation
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 begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 (CN¥, Millions)
CN¥496.6m
CN¥775.7m
CN¥1.09b
CN¥1.40b
CN¥1.70b
CN¥1.97b
CN¥2.20b
CN¥2.41b
CN¥2.58b
CN¥2.74b
Growth Rate Estimate Source
Est @ 79.01%
Est @ 56.19%
Est @ 40.21%
Est @ 29.03%
Est @ 21.20%
Est @ 15.72%
Est @ 11.89%
Est @ 9.20%
Est @ 7.33%
Est @ 6.01%
Present Value (CN¥, Millions) Discounted @ 11%
CN¥449
CN¥633
CN¥802
CN¥935
CN¥1.0k
CN¥1.1k
CN¥1.1k
CN¥1.1k
CN¥1.0k
CN¥993
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CN¥9.1b
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. 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 (2.9%) 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 11%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥36b÷ ( 1 + 11%)10= CN¥13b
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¥22b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥13.2, the company appears a touch undervalued at a 22% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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 Anhui Zhongding Sealing Parts 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 1.374. 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 Anhui Zhongding Sealing Parts
Strength
Earnings growth over the past year exceeded its 5-year average.
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Dividend information for 000887.
Weakness
Earnings growth over the past year underperformed the Auto Components industry.
Dividend is low compared to the top 25% of dividend payers in the Auto Components market.
Opportunity
Annual earnings are forecast to grow for the next 2 years.
Good value based on P/E ratio and estimated fair value.
Threat
Annual earnings are forecast to grow slower than the Chinese market.
What else are analysts forecasting for 000887?
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. 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. What is the reason for the share price sitting below the intrinsic value? For Anhui Zhongding Sealing Parts, we've compiled three important aspects you should explore:
Risks: Case in point, we've spotted 1 warning sign for Anhui Zhongding Sealing Parts you should be aware of.
Future Earnings: How does 000887'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 SZSE every day. If you want to find the calculation for other stocks 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.