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An Intrinsic Calculation For Chongqing Zhifei Biological Products Co., Ltd. (SZSE:300122) Suggests It's 35% Undervalued

Simply Wall St ·  Dec 23, 2023 20:43

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Chongqing Zhifei Biological Products fair value estimate is CN¥88.73
  • Chongqing Zhifei Biological Products' CN¥57.79 share price signals that it might be 35% undervalued
  • Our fair value estimate is 22% higher than Chongqing Zhifei Biological Products' analyst price target of CN¥72.72

Today we will run through one way of estimating the intrinsic value of Chongqing Zhifei Biological Products Co., Ltd. (SZSE:300122) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

See our latest analysis for Chongqing Zhifei Biological Products

The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF (CN¥, Millions) CN¥8.07b CN¥8.90b CN¥11.1b CN¥11.5b CN¥11.8b CN¥12.2b CN¥12.6b CN¥12.9b CN¥13.3b CN¥13.7b
Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x2 Analyst x1 Est @ 3.15% Est @ 3.10% Est @ 3.06% Est @ 3.04% Est @ 3.02% Est @ 3.01%
Present Value (CN¥, Millions) Discounted @ 7.8% CN¥7.5k CN¥7.7k CN¥8.8k CN¥8.5k CN¥8.1k CN¥7.7k CN¥7.4k CN¥7.1k CN¥6.8k CN¥6.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥76b

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 (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 7.8%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥14b× (1 + 3.0%) ÷ (7.8%– 3.0%) = CN¥291b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥291b÷ ( 1 + 7.8%)10= CN¥137b

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¥213b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥57.8, the company appears quite undervalued at a 35% 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.

dcf
SZSE:300122 Discounted Cash Flow December 24th 2023

The Assumptions

We would point out that 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 Chongqing Zhifei Biological Products 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 7.8%, 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 Chongqing Zhifei Biological Products

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
  • Dividend information for 300122.
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 Biotechs 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
  • Annual earnings are forecast to grow slower than the Chinese market.
  • What else are analysts forecasting for 300122?

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 discount to intrinsic value? For Chongqing Zhifei Biological Products, we've put together three essential factors you should further examine:

  1. Risks: We feel that you should assess the 3 warning signs for Chongqing Zhifei Biological Products (1 is a bit concerning!) we've flagged before making an investment in the company.
  2. Future Earnings: How does 300122'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.
  3. 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.

Disclaimer: This content is for informational and educational purposes only and does not constitute a recommendation or endorsement of any specific investment or investment strategy. Read more
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