Tianshan Material Co., Ltd. (SZSE:000877) Shares Could Be 41% Below Their Intrinsic Value Estimate

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Tianshan Material fair value estimate is CN¥8.59
• Tianshan Material is estimated to be 41% undervalued based on current share price of CN¥5.08
• The CN¥6.92 analyst price target for 877 is 19% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Tianshan Material Co., Ltd. (SZSE:000877) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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.

Check out our latest analysis for Tianshan Material

Is Tianshan Material Fairly Valued?

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 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.

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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	-CN¥1.56b	CN¥706.0m	CN¥5.32b	CN¥7.25b	CN¥9.16b	CN¥10.9b	CN¥12.5b	CN¥13.9b	CN¥15.1b	CN¥16.1b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 36.38%	Est @ 26.34%	Est @ 19.31%	Est @ 14.38%	Est @ 10.94%	Est @ 8.53%	Est @ 6.84%
Present Value (CN¥, Millions) Discounted @ 14%	-CN¥1.4k	CN¥542	CN¥3.6k	CN¥4.3k	CN¥4.7k	CN¥4.9k	CN¥4.9k	CN¥4.8k	CN¥4.6k	CN¥4.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥35b

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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥16b× (1 + 2.9%) ÷ (14%– 2.9%) = CN¥147b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥147b÷ ( 1 + 14%)¹⁰= CN¥39b

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¥74b. 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¥5.1, the company appears quite good value at a 41% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Tianshan Material 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 14%, which is based on a levered beta of 2.000. 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 Tianshan Material

Next Steps:

Whilst important, the DCF calculation 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. 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. What is the reason for the share price sitting below the intrinsic value? For Tianshan Material, we've compiled three pertinent items you should explore:

1. Risks: Case in point, we've spotted 4 warning signs for Tianshan Material you should be aware of, and 1 of them can't be ignored.
2. Future Earnings: How does 000877'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. 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