Is Zhejiang Giuseppe Garment Co., Ltd (SZSE:002687) Trading At A 33% Discount?

Key Insights

• The projected fair value for Zhejiang Giuseppe Garment is CN¥6.21 based on 2 Stage Free Cash Flow to Equity
• Zhejiang Giuseppe Garment's CN¥4.19 share price signals that it might be 33% undervalued
• The average premium for Zhejiang Giuseppe Garment's competitorsis currently 1,891%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Zhejiang Giuseppe Garment Co., Ltd (SZSE:002687) as an investment opportunity by estimating the company's future cash flows and discounting them to their present 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 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.

Check out our latest analysis for Zhejiang Giuseppe Garment

Is Zhejiang Giuseppe Garment Fairly Valued?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥185.7m	CN¥182.9m	CN¥182.5m	CN¥183.8m	CN¥186.3m	CN¥189.6m	CN¥193.6m	CN¥198.2m	CN¥203.1m	CN¥208.4m
Growth Rate Estimate Source	Est @ -3.38%	Est @ -1.51%	Est @ -0.20%	Est @ 0.71%	Est @ 1.35%	Est @ 1.80%	Est @ 2.12%	Est @ 2.34%	Est @ 2.49%	Est @ 2.60%
Present Value (CN¥, Millions) Discounted @ 8.3%	CN¥171	CN¥156	CN¥144	CN¥134	CN¥125	CN¥118	CN¥111	CN¥105	CN¥99.4	CN¥94.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.3b

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 8.3%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥208m× (1 + 2.9%) ÷ (8.3%– 2.9%) = CN¥4.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥4.0b÷ ( 1 + 8.3%)¹⁰= CN¥1.8b

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¥3.0b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CN¥4.2, the company appears quite undervalued at a 33% 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

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 Zhejiang Giuseppe Garment 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 8.3%, which is based on a levered beta of 1.088. 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 shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Can we work out why the company is trading at a discount to intrinsic value? For Zhejiang Giuseppe Garment, we've put together three essential aspects you should further examine:

1. Risks: Be aware that Zhejiang Giuseppe Garment is showing 1 warning sign in our investment analysis , you should know about...
2. Future Earnings: How does 002687'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 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!

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.

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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.