- Zoomlion Heavy Industry Science and Technology's estimated fair value is CN¥11.17 based on 2 Stage Free Cash Flow to Equity
- Zoomlion Heavy Industry Science and Technology's CN¥6.50 share price signals that it might be 42% undervalued
- Analyst price target for 157 is CN¥7.14 which is 36% below our fair value estimate
Today we will run through one way of estimating the intrinsic value of Zoomlion Heavy Industry Science and Technology Co., Ltd. (SZSE:000157) 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for Zoomlion Heavy Industry Science and Technology
Is Zoomlion Heavy Industry Science and Technology 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
|Levered FCF (CN¥, Millions)
|Growth Rate Estimate Source
|Est @ 24.40%
|Est @ 17.98%
|Est @ 13.48%
|Est @ 10.33%
|Est @ 8.12%
|Est @ 6.58%
|Est @ 5.50%
|Est @ 4.74%
|Present Value (CN¥, Millions) Discounted @ 11%
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥41b
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 (3.0%) 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%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥11b× (1 + 3.0%) ÷ (11%– 3.0%) = CN¥142b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥142b÷ ( 1 + 11%)10= CN¥51b
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¥92b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥6.5, the company appears quite good value at a 42% 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.
Now 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 Zoomlion Heavy Industry Science and Technology 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 1.269. 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 Zoomlion Heavy Industry Science and Technology
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Dividend is in the top 25% of dividend payers in the market.
- Dividend information for 000157.
- No major weaknesses identified for 000157.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Dividends are not covered by cash flow.
- Annual earnings are forecast to grow slower than the Chinese market.
- Is 000157 well equipped to handle threats?
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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. Why is the intrinsic value higher than the current share price? For Zoomlion Heavy Industry Science and Technology, we've put together three further elements you should consider:
- Risks: For instance, we've identified 1 warning sign for Zoomlion Heavy Industry Science and Technology that you should be aware of.
- Future Earnings: How does 000157'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. 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.
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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.