Calculating The Intrinsic Value Of Zhejiang Weixing New Building Materials Co., Ltd. (SZSE:002372)

Key Insights

• The projected fair value for Zhejiang Weixing New Building Materials is CN¥11.47 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥12.48 suggests Zhejiang Weixing New Building Materials is potentially trading close to its fair value
• Analyst price target for 002372 is CN¥14.61, which is 27% above our fair value estimate

In this article we are going to estimate the intrinsic value of Zhejiang Weixing New Building Materials Co., Ltd. (SZSE:002372) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Zhejiang Weixing New Building Materials

The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥1.04b	CN¥1.13b	CN¥1.14b	CN¥1.16b	CN¥1.19b	CN¥1.22b	CN¥1.25b	CN¥1.28b	CN¥1.31b	CN¥1.35b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 1.56%	Est @ 1.91%	Est @ 2.16%	Est @ 2.33%	Est @ 2.46%	Est @ 2.54%	Est @ 2.60%	Est @ 2.64%
Present Value (CN¥, Millions) Discounted @ 8.6%	CN¥961	CN¥954	CN¥892	CN¥836	CN¥787	CN¥741	CN¥699	CN¥660	CN¥623	CN¥589

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥7.7b

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 (2.7%) 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 8.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥1.3b× (1 + 2.7%) ÷ (8.6%– 2.7%) = CN¥24b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥24b÷ ( 1 + 8.6%)¹⁰= CN¥10b

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¥18b. 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¥12.5, the company appears around fair value at the time of writing. 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

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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Zhejiang Weixing New Building Materials 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 8.6%, which is based on a levered beta of 1.116. 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.

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SWOT Analysis for Zhejiang Weixing New Building Materials

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Zhejiang Weixing New Building Materials, we've put together three important aspects you should look at:

1. Risks: Take risks, for example - Zhejiang Weixing New Building Materials has 2 warning signs we think you should be aware of.
2. Future Earnings: How does 002372'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.

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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.