A Look At The Intrinsic Value Of Zhejiang Great Shengda Packaging Co.,Ltd. (SHSE:603687)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Zhejiang Great Shengda PackagingLtd fair value estimate is CN¥8.01
• Current share price of CN¥9.12 suggests Zhejiang Great Shengda PackagingLtd is potentially trading close to its fair value
• Zhejiang Great Shengda PackagingLtd's peers seem to be trading at a higher premium to fair value based onthe industry average of -1,177%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Zhejiang Great Shengda Packaging Co.,Ltd. (SHSE:603687) 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. 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. 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.

See our latest analysis for Zhejiang Great Shengda PackagingLtd

Crunching The Numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥99.6m	CN¥128.8m	CN¥156.3m	CN¥181.1m	CN¥202.7m	CN¥221.5m	CN¥237.7m	CN¥252.0m	CN¥264.8m	CN¥276.5m
Growth Rate Estimate Source	Est @ 40.62%	Est @ 29.31%	Est @ 21.38%	Est @ 15.84%	Est @ 11.96%	Est @ 9.24%	Est @ 7.34%	Est @ 6.01%	Est @ 5.07%	Est @ 4.42%
Present Value (CN¥, Millions) Discounted @ 7.4%	CN¥92.7	CN¥112	CN¥126	CN¥136	CN¥142	CN¥144	CN¥144	CN¥142	CN¥139	CN¥135

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

The second stage is also known as Terminal Value, this is the business's cash flow after 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 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥276m× (1 + 2.9%) ÷ (7.4%– 2.9%) = CN¥6.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥6.3b÷ ( 1 + 7.4%)¹⁰= CN¥3.1b

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¥4.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CN¥9.1, the company appears around fair value at the time of writing. 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

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 Zhejiang Great Shengda PackagingLtd 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 ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Zhejiang Great Shengda PackagingLtd, we've put together three pertinent items you should consider:

1. Risks: You should be aware of the 2 warning signs for Zhejiang Great Shengda PackagingLtd (1 is significant!) we've uncovered before considering an investment in the company.
2. 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!
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. 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.