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¥19.61 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥18.17 suggests Qinghai Salt Lake IndustryLtd is potentially trading close to its fair value
• Our fair value estimate is 18% higher than Qinghai Salt Lake IndustryLtd's analyst price target of CN¥16.68

In this article we are going to estimate the intrinsic value of Qinghai Salt Lake Industry Co.,Ltd (SZSE:000792) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 Qinghai Salt Lake IndustryLtd

Is Qinghai Salt Lake IndustryLtd Fairly Valued?

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. 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, 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) 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¥5.87b	CN¥5.92b	CN¥6.00b	CN¥6.11b	CN¥6.24b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -5.45%	Est @ -2.98%	Est @ -1.24%	Est @ -0.03%	Est @ 0.82%	Est @ 1.41%	Est @ 1.83%	Est @ 2.12%
Present Value (CN¥, Millions) Discounted @ 7.6%	CN¥5.0k	CN¥5.6k	CN¥4.9k	CN¥4.4k	CN¥4.1k	CN¥3.8k	CN¥3.5k	CN¥3.3k	CN¥3.2k	CN¥3.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥41b

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 (2.8%) 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 7.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥6.2b× (1 + 2.8%) ÷ (7.6%– 2.8%) = CN¥134b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥134b÷ ( 1 + 7.6%)¹⁰= CN¥64b

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¥105b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥18.2, the company appears about fair value at a 7.3% 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 7.6%, which is based on a levered beta of 0.962. 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

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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 Qinghai Salt Lake IndustryLtd, we've compiled three further elements you should look at:

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 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. 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.