Estimating The Fair Value Of Zhejiang Hangmin Co.,Ltd (SHSE:600987)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Zhejiang HangminLtd fair value estimate is CN¥6.13
• Zhejiang HangminLtd's CN¥6.48 share price indicates it is trading at similar levels as its fair value estimate
• Industry average of 432% suggests Zhejiang HangminLtd's peers are currently trading at a higher premium to fair value

How far off is Zhejiang Hangmin Co.,Ltd (SHSE:600987) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. 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 Zhejiang HangminLtd

Crunching The Numbers

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 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.

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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥504.7m	CN¥470.2m	CN¥451.7m	CN¥443.3m	CN¥441.3m	CN¥443.8m	CN¥449.4m	CN¥457.3m	CN¥466.9m	CN¥477.8m
Growth Rate Estimate Source	Est @ -11.02%	Est @ -6.84%	Est @ -3.92%	Est @ -1.87%	Est @ -0.44%	Est @ 0.56%	Est @ 1.26%	Est @ 1.75%	Est @ 2.10%	Est @ 2.34%
Present Value (CN¥, Millions) Discounted @ 8.9%	CN¥463	CN¥396	CN¥349	CN¥315	CN¥288	CN¥266	CN¥247	CN¥231	CN¥216	CN¥203

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥3.0b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 8.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥478m× (1 + 2.9%) ÷ (8.9%– 2.9%) = CN¥8.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥8.1b÷ ( 1 + 8.9%)¹⁰= CN¥3.5b

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¥6.4b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥6.5, 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 HangminLtd 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 8.9%, which is based on a levered beta of 1.072. 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:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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 Zhejiang HangminLtd, there are three additional aspects you should consider:

1. Risks: Take risks, for example - Zhejiang HangminLtd has 1 warning sign we think you should be aware of.
2. 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!
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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com