Estimating The Fair Value Of Zhongnongfa Seed Industry Group Co., Ltd. (SHSE:600313)

Key Insights

• Zhongnongfa Seed Industry Group's estimated fair value is CN¥7.06 based on 2 Stage Free Cash Flow to Equity
• Zhongnongfa Seed Industry Group's CN¥6.79 share price indicates it is trading at similar levels as its fair value estimate
• Peers of Zhongnongfa Seed Industry Group are currently trading on average at a 341% premium

How far off is Zhongnongfa Seed Industry Group Co., Ltd. (SHSE:600313) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Zhongnongfa Seed Industry Group

Is Zhongnongfa Seed Industry Group Fairly Valued?

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 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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¥321.6m	CN¥363.3m	CN¥399.5m	CN¥430.9m	CN¥458.3m	CN¥482.9m	CN¥505.2m	CN¥526.0m	CN¥545.8m	CN¥565.0m
Growth Rate Estimate Source	Est @ 17.26%	Est @ 12.97%	Est @ 9.96%	Est @ 7.85%	Est @ 6.38%	Est @ 5.35%	Est @ 4.63%	Est @ 4.12%	Est @ 3.77%	Est @ 3.52%
Present Value (CN¥, Millions) Discounted @ 8.4%	CN¥297	CN¥309	CN¥313	CN¥312	CN¥306	CN¥297	CN¥287	CN¥275	CN¥264	CN¥252

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥2.9b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 8.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥565m× (1 + 2.9%) ÷ (8.4%– 2.9%) = CN¥11b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥11b÷ ( 1 + 8.4%)¹⁰= CN¥4.7b

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¥7.6b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥6.8, the company appears about fair value at a 3.8% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important 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. 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 Zhongnongfa Seed Industry Group 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 8.4%, which is based on a levered beta of 0.974. 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.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Zhongnongfa Seed Industry Group, there are three essential elements you should assess:

1. Risks: Every company has them, and we've spotted 1 warning sign for Zhongnongfa Seed Industry Group you should know about.
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.

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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.