Estimating The Intrinsic Value Of Jianshe Industry Group (Yunnan) Co., Ltd. (SZSE:002265)

Key Insights

• Jianshe Industry Group (Yunnan)'s estimated fair value is CN¥8.86 based on 2 Stage Free Cash Flow to Equity
• Jianshe Industry Group (Yunnan)'s CN¥10.32 share price indicates it is trading at similar levels as its fair value estimate
• Jianshe Industry Group (Yunnan)'s peers seem to be trading at a higher premium to fair value based onthe industry average of -3,941%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Jianshe Industry Group (Yunnan) Co., Ltd. (SZSE:002265) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Jianshe Industry Group (Yunnan)

Crunching The Numbers

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥425.8m	CN¥501.3m	CN¥567.9m	CN¥625.8m	CN¥675.9m	CN¥719.8m	CN¥758.8m	CN¥794.4m	CN¥827.4m	CN¥858.8m
Growth Rate Estimate Source	Est @ 24.07%	Est @ 17.73%	Est @ 13.29%	Est @ 10.19%	Est @ 8.01%	Est @ 6.49%	Est @ 5.43%	Est @ 4.68%	Est @ 4.16%	Est @ 3.79%
Present Value (CN¥, Millions) Discounted @ 9.7%	CN¥388	CN¥417	CN¥430	CN¥432	CN¥425	CN¥413	CN¥397	CN¥379	CN¥359	CN¥340

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥4.0b

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 9.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥859m× (1 + 2.9%) ÷ (9.7%– 2.9%) = CN¥13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥13b÷ ( 1 + 9.7%)¹⁰= CN¥5.2b

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¥9.2b. 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¥10.3, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important 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 Jianshe Industry Group (Yunnan) 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 9.7%, which is based on a levered beta of 1.201. 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.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Jianshe Industry Group (Yunnan), we've compiled three essential items you should look at:

1. Risks: Take risks, for example - Jianshe Industry Group (Yunnan) has 3 warning signs we think 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 Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.