Estimating The Fair Value Of Qinghai Salt Lake Industry Co.,Ltd (SZSE:000792)

Key Insights

• Qinghai Salt Lake IndustryLtd's estimated fair value is CN¥18.95 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥16.87 suggests Qinghai Salt Lake IndustryLtd is potentially trading close to its fair value
• Analyst price target for 000792 is CN¥17.30 which is 8.7% below our fair value estimate

How far off is Qinghai Salt Lake Industry Co.,Ltd (SZSE:000792) 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. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Qinghai Salt Lake IndustryLtd

The Calculation

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. 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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥5.41b	CN¥6.48b	CN¥6.13b	CN¥5.94b	CN¥5.87b	CN¥5.86b	CN¥5.91b	CN¥5.99b	CN¥6.09b	CN¥6.22b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -5.47%	Est @ -3.01%	Est @ -1.28%	Est @ -0.08%	Est @ 0.77%	Est @ 1.36%	Est @ 1.77%	Est @ 2.06%
Present Value (CN¥, Millions) Discounted @ 7.8%	CN¥5.0k	CN¥5.6k	CN¥4.9k	CN¥4.4k	CN¥4.0k	CN¥3.7k	CN¥3.5k	CN¥3.3k	CN¥3.1k	CN¥2.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥40b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.7%. We discount the terminal cash flows to today's value at a cost of equity of 7.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥6.2b× (1 + 2.7%) ÷ (7.8%– 2.7%) = CN¥127b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥127b÷ ( 1 + 7.8%)¹⁰= CN¥60b

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¥100b. 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¥16.9, the company appears about fair value at a 11% 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

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 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 7.8%, which is based on a levered beta of 0.958. 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.

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SWOT Analysis for Qinghai Salt Lake IndustryLtd

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Qinghai Salt Lake IndustryLtd, we've put together three essential items you should further research:

1. Financial Health: Does 000792 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 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 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.