Yunnan Shennong Agricultural Industry Group Co.,LTD.'s (SHSE:605296) Intrinsic Value Is Potentially 89% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Yunnan Shennong Agricultural Industry GroupLTD fair value estimate is CN¥79.74
• Yunnan Shennong Agricultural Industry GroupLTD's CN¥42.10 share price signals that it might be 47% undervalued
• The CN¥45.30 analyst price target for 605296 is 43% less than our estimate of fair value

How far off is Yunnan Shennong Agricultural Industry Group Co.,LTD. (SHSE:605296) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. 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 Yunnan Shennong Agricultural Industry GroupLTD

The Method

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	-CN¥403.0m	CN¥836.0m	CN¥1.23b	CN¥1.53b	CN¥1.82b	CN¥2.07b	CN¥2.29b	CN¥2.48b	CN¥2.64b	CN¥2.79b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 25.19%	Est @ 18.51%	Est @ 13.82%	Est @ 10.55%	Est @ 8.25%	Est @ 6.65%	Est @ 5.52%
Present Value (CN¥, Millions) Discounted @ 7.4%	-CN¥375	CN¥725	CN¥989	CN¥1.2k	CN¥1.3k	CN¥1.3k	CN¥1.4k	CN¥1.4k	CN¥1.4k	CN¥1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥11b

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 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥2.8b× (1 + 2.9%) ÷ (7.4%– 2.9%) = CN¥64b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥64b÷ ( 1 + 7.4%)¹⁰= CN¥31b

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¥42b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥42.1, the company appears quite undervalued at a 47% 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. 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 Yunnan Shennong Agricultural Industry GroupLTD 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 7.4%, 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.

Looking Ahead:

Whilst important, the DCF calculation 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Yunnan Shennong Agricultural Industry GroupLTD, we've put together three important aspects you should further research:

1. Financial Health: Does 605296 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does 605296'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 SHSE 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.