Are Investors Undervaluing Joyoung Co.,Ltd (SZSE:002242) By 32%?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, JoyoungLtd fair value estimate is CN¥16.10
• JoyoungLtd is estimated to be 32% undervalued based on current share price of CN¥10.99
• The CN¥14.20 analyst price target for 2242 is 12% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Joyoung Co.,Ltd (SZSE:002242) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. 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 JoyoungLtd

What's The Estimated Valuation?

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 begin with, we have to get estimates of 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.

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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥570.0m	CN¥689.5m	CN¥779.9m	CN¥858.3m	CN¥926.3m	CN¥985.9m	CN¥1.04b	CN¥1.09b	CN¥1.13b	CN¥1.17b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Est @ 13.11%	Est @ 10.06%	Est @ 7.92%	Est @ 6.43%	Est @ 5.38%	Est @ 4.65%	Est @ 4.14%	Est @ 3.78%
Present Value (CN¥, Millions) Discounted @ 9.8%	CN¥519	CN¥572	CN¥589	CN¥590	CN¥580	CN¥562	CN¥539	CN¥514	CN¥487	CN¥460

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥5.4b

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 9.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥1.2b× (1 + 2.9%) ÷ (9.8%– 2.9%) = CN¥18b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥18b÷ ( 1 + 9.8%)¹⁰= CN¥6.9b

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¥12b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥11.0, the company appears quite undervalued at a 32% 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.

The 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 JoyoungLtd 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 9.8%, which is based on a levered beta of 1.224. 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 JoyoungLtd

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For JoyoungLtd, we've put together three additional elements you should explore:

1. Risks: Case in point, we've spotted 1 warning sign for JoyoungLtd you should be aware of.
2. Future Earnings: How does 002242'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SZSE every day. If you want to find the calculation for other stocks 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.