A Look At The Intrinsic Value Of Guangzhou Tinci Materials Technology Co., Ltd. (SZSE:002709)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Guangzhou Tinci Materials Technology fair value estimate is CN¥14.74
• Current share price of CN¥13.24 suggests Guangzhou Tinci Materials Technology is potentially trading close to its fair value
• Analyst price target for 002709 is CN¥18.21, which is 24% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of Guangzhou Tinci Materials Technology Co., Ltd. (SZSE:002709) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Guangzhou Tinci Materials Technology

The Method

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥1.62b	CN¥1.61b	CN¥1.62b	CN¥1.63b	CN¥1.66b	CN¥1.69b	CN¥1.73b	CN¥1.77b	CN¥1.82b	CN¥1.87b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 0.34%	Est @ 1.09%	Est @ 1.62%	Est @ 1.99%	Est @ 2.25%	Est @ 2.43%	Est @ 2.55%	Est @ 2.64%
Present Value (CN¥, Millions) Discounted @ 8.1%	CN¥1.5k	CN¥1.4k	CN¥1.3k	CN¥1.2k	CN¥1.1k	CN¥1.1k	CN¥1.0k	CN¥952	CN¥904	CN¥858

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥11b

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. 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 8.1%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥1.9b× (1 + 2.9%) ÷ (8.1%– 2.9%) = CN¥37b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥37b÷ ( 1 + 8.1%)¹⁰= CN¥17b

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¥28b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CN¥13.2, the company appears about fair value at a 10% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Guangzhou Tinci Materials Technology 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 8.1%, which is based on a levered beta of 1.050. 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 Guangzhou Tinci Materials Technology

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 Guangzhou Tinci Materials Technology, we've put together three fundamental aspects you should explore:

1. Risks: Be aware that Guangzhou Tinci Materials Technology is showing 2 warning signs in our investment analysis , you should know about...
2. Future Earnings: How does 002709'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.