A Look At The Intrinsic Value Of Anhui Jianghuai Automobile Group Corp.,Ltd. (SHSE:600418)

Key Insights

• Anhui Jianghuai Automobile GroupLtd's estimated fair value is CN¥23.15 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥22.04 suggests Anhui Jianghuai Automobile GroupLtd is potentially trading close to its fair value
• Analyst price target for 600418 is CN¥21.22 which is 8.3% below our fair value estimate

In this article we are going to estimate the intrinsic value of Anhui Jianghuai Automobile Group Corp.,Ltd. (SHSE:600418) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Anhui Jianghuai Automobile GroupLtd

Step By Step Through 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. To start off with, we need to estimate 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥2.36b	CN¥3.05b	CN¥3.69b	CN¥4.27b	CN¥4.78b	CN¥5.21b	CN¥5.59b	CN¥5.92b	CN¥6.22b	CN¥6.49b
Growth Rate Estimate Source	Est @ 40.20%	Est @ 28.99%	Est @ 21.15%	Est @ 15.66%	Est @ 11.82%	Est @ 9.13%	Est @ 7.24%	Est @ 5.93%	Est @ 5.00%	Est @ 4.36%
Present Value (CN¥, Millions) Discounted @ 12%	CN¥2.1k	CN¥2.4k	CN¥2.7k	CN¥2.8k	CN¥2.8k	CN¥2.7k	CN¥2.6k	CN¥2.5k	CN¥2.3k	CN¥2.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥25b

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 (2.9%) 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 12%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥6.5b× (1 + 2.9%) ÷ (12%– 2.9%) = CN¥76b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥76b÷ ( 1 + 12%)¹⁰= CN¥26b

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¥51b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥22.0, the company appears about fair value at a 4.8% 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.

Important Assumptions

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 Anhui Jianghuai Automobile GroupLtd 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 12%, which is based on a levered beta of 1.752. 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 Jianghuai Automobile GroupLtd

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. For Anhui Jianghuai Automobile GroupLtd, we've put together three further elements you should assess:

1. Risks: For instance, we've identified 2 warning signs for Anhui Jianghuai Automobile GroupLtd that you should be aware of.
2. Future Earnings: How does 600418'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 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.

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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.