A Look At The Intrinsic Value Of Wanxiang Qianchao Co.,Ltd. (SZSE:000559)

Key Insights

• The projected fair value for Wanxiang QianchaoLtd is CN¥7.59 based on 2 Stage Free Cash Flow to Equity
• Wanxiang QianchaoLtd's CN¥6.90 share price indicates it is trading at similar levels as its fair value estimate
• The average premium for Wanxiang QianchaoLtd's competitorsis currently 950%

How far off is Wanxiang Qianchao Co.,Ltd. (SZSE:000559) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 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 Wanxiang QianchaoLtd

The Method

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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥1.27b	CN¥1.38b	CN¥1.48b	CN¥1.57b	CN¥1.65b	CN¥1.72b	CN¥1.79b	CN¥1.85b	CN¥1.92b	CN¥1.98b
Growth Rate Estimate Source	Est @ 11.98%	Est @ 9.23%	Est @ 7.30%	Est @ 5.95%	Est @ 5.00%	Est @ 4.34%	Est @ 3.88%	Est @ 3.56%	Est @ 3.33%	Est @ 3.17%
Present Value (CN¥, Millions) Discounted @ 8.8%	CN¥1.2k	CN¥1.2k	CN¥1.2k	CN¥1.1k	CN¥1.1k	CN¥1.0k	CN¥994	CN¥946	CN¥898	CN¥852

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

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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥2.0b× (1 + 2.8%) ÷ (8.8%– 2.8%) = CN¥34b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥34b÷ ( 1 + 8.8%)¹⁰= CN¥15b

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¥25b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CN¥6.9, the company appears about fair value at a 9.1% 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

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. 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 Wanxiang QianchaoLtd 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 8.8%, which is based on a levered beta of 1.200. 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.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Wanxiang QianchaoLtd, we've compiled three fundamental elements you should explore:

1. Risks: For instance, we've identified 1 warning sign for Wanxiang QianchaoLtd that you should be aware of.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.