A Look At The Intrinsic Value Of Zhejiang Century Huatong Group Co.,Ltd (SZSE:002602)

Key Insights

• Zhejiang Century Huatong GroupLtd's estimated fair value is CN¥4.76 based on 2 Stage Free Cash Flow to Equity
• Zhejiang Century Huatong GroupLtd's CN¥4.40 share price indicates it is trading at similar levels as its fair value estimate
• Analyst price target for 2602 is CN¥7.78, which is 63% above our fair value estimate

Does the April share price for Zhejiang Century Huatong Group Co.,Ltd (SZSE:002602) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. 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.

View our latest analysis for Zhejiang Century Huatong GroupLtd

The Model

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 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, 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¥1.83b	CN¥2.01b	CN¥2.17b	CN¥2.30b	CN¥2.43b	CN¥2.54b	CN¥2.64b	CN¥2.74b	CN¥2.84b	CN¥2.93b
Growth Rate Estimate Source	Est @ 12.77%	Est @ 9.82%	Est @ 7.76%	Est @ 6.31%	Est @ 5.30%	Est @ 4.59%	Est @ 4.10%	Est @ 3.75%	Est @ 3.51%	Est @ 3.34%
Present Value (CN¥, Millions) Discounted @ 9.2%	CN¥1.7k	CN¥1.7k	CN¥1.7k	CN¥1.6k	CN¥1.6k	CN¥1.5k	CN¥1.4k	CN¥1.4k	CN¥1.3k	CN¥1.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥15b

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 9.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥2.9b× (1 + 2.9%) ÷ (9.2%– 2.9%) = CN¥48b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥48b÷ ( 1 + 9.2%)¹⁰= CN¥20b

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¥35b. 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¥4.4, the company appears about fair value at a 7.6% 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. 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 Zhejiang Century Huatong 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 9.2%, which is based on a levered beta of 1.110. 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.

Moving On:

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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Zhejiang Century Huatong GroupLtd, there are three essential elements you should consider:

1. Financial Health: Does 002602 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does 002602'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.