Are Investors Undervaluing Qinghai Salt Lake Industry Co.,Ltd (SZSE:000792) By 45%?

Key Insights

• The projected fair value for Qinghai Salt Lake IndustryLtd is CN¥27.96 based on 2 Stage Free Cash Flow to Equity
• Qinghai Salt Lake IndustryLtd is estimated to be 45% undervalued based on current share price of CN¥15.26
• Analyst price target for 000792 is CN¥18.16 which is 35% below our fair value estimate

Does the July share price for Qinghai Salt Lake Industry Co.,Ltd (SZSE:000792) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 Qinghai Salt Lake IndustryLtd

Is Qinghai Salt Lake IndustryLtd 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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥9.39b	CN¥9.86b	CN¥9.52b	CN¥9.38b	CN¥9.36b	CN¥9.43b	CN¥9.56b	CN¥9.73b	CN¥9.94b	CN¥10.2b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -3.43%	Est @ -1.53%	Est @ -0.20%	Est @ 0.73%	Est @ 1.38%	Est @ 1.84%	Est @ 2.16%	Est @ 2.38%
Present Value (CN¥, Millions) Discounted @ 8.3%	CN¥8.7k	CN¥8.4k	CN¥7.5k	CN¥6.8k	CN¥6.3k	CN¥5.8k	CN¥5.5k	CN¥5.1k	CN¥4.8k	CN¥4.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥63b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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¥10b× (1 + 2.9%) ÷ (8.3%– 2.9%) = CN¥193b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥193b÷ ( 1 + 8.3%)¹⁰= CN¥87b

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¥150b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥15.3, the company appears quite undervalued at a 45% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The 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 Qinghai Salt Lake IndustryLtd 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 0.965. 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 Qinghai Salt Lake IndustryLtd

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For Qinghai Salt Lake IndustryLtd, we've put together three fundamental factors you should explore:

1. Risks: For example, we've discovered 1 warning sign for Qinghai Salt Lake IndustryLtd that you should be aware of before investing here.
2. Future Earnings: How does 000792'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 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!

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com