Is There An Opportunity With Zhejiang Daily Digital Culture Group Co.,Ltd's (SHSE:600633) 26% Undervaluation?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Zhejiang Daily Digital Culture GroupLtd fair value estimate is CN¥15.51
• Zhejiang Daily Digital Culture GroupLtd is estimated to be 26% undervalued based on current share price of CN¥11.41
• The average premium for Zhejiang Daily Digital Culture GroupLtd's competitorsis currently 1,310%

Does the December share price for Zhejiang Daily Digital Culture Group Co.,Ltd (SHSE:600633) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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 Zhejiang Daily Digital Culture GroupLtd

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. 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, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥846.0m	CN¥974.0m	CN¥1.07b	CN¥1.15b	CN¥1.23b	CN¥1.29b	CN¥1.35b	CN¥1.40b	CN¥1.45b	CN¥1.50b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 9.90%	Est @ 7.77%	Est @ 6.28%	Est @ 5.24%	Est @ 4.51%	Est @ 3.99%	Est @ 3.64%	Est @ 3.39%
Present Value (CN¥, Millions) Discounted @ 8.5%	CN¥780	CN¥827	CN¥838	CN¥832	CN¥815	CN¥790	CN¥761	CN¥729	CN¥696	CN¥663

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥7.7b

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥1.5b× (1 + 2.8%) ÷ (8.5%– 2.8%) = CN¥27b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥27b÷ ( 1 + 8.5%)¹⁰= CN¥12b

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¥20b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥11.4, the company appears a touch undervalued at a 26% 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

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 Zhejiang Daily Digital Culture GroupLtd 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 8.5%, which is based on a levered beta of 1.150. 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 Zhejiang Daily Digital Culture GroupLtd

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Zhejiang Daily Digital Culture GroupLtd, we've compiled three important items you should consider:

1. Risks: For instance, we've identified 3 warning signs for Zhejiang Daily Digital Culture GroupLtd that you should be aware of.
2. Future Earnings: How does 600633'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.