Estimating The Fair Value Of Guangzhou Jointas Chemical Co., Ltd. (SZSE:002909)

Key Insights

• The projected fair value for Guangzhou Jointas Chemical is CN¥3.13 based on 2 Stage Free Cash Flow to Equity
• Guangzhou Jointas Chemical's CN¥3.62 share price indicates it is trading at similar levels as its fair value estimate
• Industry average of 449% suggests Guangzhou Jointas Chemical's peers are currently trading at a higher premium to fair value

In this article we are going to estimate the intrinsic value of Guangzhou Jointas Chemical Co., Ltd. (SZSE:002909) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Guangzhou Jointas Chemical

Step By Step Through The Calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 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¥27.0m	CN¥40.1m	CN¥54.0m	CN¥67.6m	CN¥80.2m	CN¥91.3m	CN¥100.9m	CN¥109.2m	CN¥116.5m	CN¥122.9m
Growth Rate Estimate Source	Est @ 68.01%	Est @ 48.48%	Est @ 34.81%	Est @ 25.23%	Est @ 18.53%	Est @ 13.84%	Est @ 10.56%	Est @ 8.26%	Est @ 6.65%	Est @ 5.53%
Present Value (CN¥, Millions) Discounted @ 9.5%	CN¥24.6	CN¥33.4	CN¥41.1	CN¥47.0	CN¥50.9	CN¥53.0	CN¥53.5	CN¥52.9	CN¥51.5	CN¥49.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥458m

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 9.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥123m× (1 + 2.9%) ÷ (9.5%– 2.9%) = CN¥1.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥1.9b÷ ( 1 + 9.5%)¹⁰= CN¥774m

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¥1.2b. 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¥3.6, the company appears around fair value at the time of writing. 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

Now 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 Guangzhou Jointas Chemical 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 9.5%, which is based on a levered beta of 1.172. 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 Jointas Chemical

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. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Guangzhou Jointas Chemical, we've compiled three relevant items you should explore:

1. Risks: To that end, you should learn about the 3 warning signs we've spotted with Guangzhou Jointas Chemical (including 2 which shouldn't be ignored) .
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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