Shanxi Xinghuacun Fen Wine Factory Co.,Ltd.'s (SHSE:600809) Intrinsic Value Is Potentially 98% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Shanxi Xinghuacun Fen Wine FactoryLtd fair value estimate is CN¥358
• Shanxi Xinghuacun Fen Wine FactoryLtd's CN¥181 share price signals that it might be 50% undervalued
• Analyst price target for 600809 is CN¥239 which is 33% below our fair value estimate

In this article we are going to estimate the intrinsic value of Shanxi Xinghuacun Fen Wine Factory Co.,Ltd. (SHSE:600809) by taking the expected future cash flows and 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!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Shanxi Xinghuacun Fen Wine FactoryLtd

Is Shanxi Xinghuacun Fen Wine FactoryLtd 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. 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) forecast

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥131b

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. 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 6.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥23b× (1 + 2.9%) ÷ (6.8%– 2.9%) = CN¥592b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥592b÷ ( 1 + 6.8%)¹⁰= CN¥306b

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¥437b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥181, the company appears quite good value at a 50% 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Shanxi Xinghuacun Fen Wine FactoryLtd 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 6.8%, which is based on a levered beta of 0.800. 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 Shanxi Xinghuacun Fen Wine FactoryLtd

Next Steps:

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. 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. What is the reason for the share price sitting below the intrinsic value? For Shanxi Xinghuacun Fen Wine FactoryLtd, we've put together three important factors you should further examine:

1. Risks: Take risks, for example - Shanxi Xinghuacun Fen Wine FactoryLtd has 2 warning signs (and 1 which is potentially serious) we think you should know about.
2. Future Earnings: How does 600809'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. 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.