Is There An Opportunity With Jiangxi Black Cat Carbon Black Inc.,Ltd's (SZSE:002068) 43% Undervaluation?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Jiangxi Black Cat Carbon BlackLtd fair value estimate is CN¥14.76
• Current share price of CN¥8.46 suggests Jiangxi Black Cat Carbon BlackLtd is potentially 43% undervalued
• The average premium for Jiangxi Black Cat Carbon BlackLtd's competitorsis currently 314%

How far off is Jiangxi Black Cat Carbon Black Inc.,Ltd (SZSE:002068) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Jiangxi Black Cat Carbon BlackLtd

Crunching The Numbers

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥337.7m	CN¥445.7m	CN¥549.4m	CN¥643.8m	CN¥726.9m	CN¥799.0m	CN¥861.5m	CN¥916.2m	CN¥965.1m	CN¥1.01b
Growth Rate Estimate Source	Est @ 44.44%	Est @ 31.99%	Est @ 23.28%	Est @ 17.18%	Est @ 12.91%	Est @ 9.92%	Est @ 7.82%	Est @ 6.36%	Est @ 5.33%	Est @ 4.61%
Present Value (CN¥, Millions) Discounted @ 9.3%	CN¥309	CN¥373	CN¥421	CN¥451	CN¥466	CN¥468	CN¥462	CN¥449	CN¥433	CN¥414

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥4.2b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 9.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥1.0b× (1 + 2.9%) ÷ (9.3%– 2.9%) = CN¥16b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥16b÷ ( 1 + 9.3%)¹⁰= CN¥6.7b

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¥11b. 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¥8.5, the company appears quite undervalued at a 43% 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

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. 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 Jiangxi Black Cat Carbon BlackLtd 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 9.3%, which is based on a levered beta of 1.132. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Jiangxi Black Cat Carbon BlackLtd, we've put together three additional elements you should further research:

1. Risks: For instance, we've identified 1 warning sign for Jiangxi Black Cat Carbon BlackLtd that you should be aware of.
2. Future Earnings: How does 002068'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.