Estimating The Intrinsic Value Of Aoyuan Beauty Valley Technology Co.,Ltd. (SZSE:000615)

Key Insights

• The projected fair value for Aoyuan Beauty Valley TechnologyLtd is CN¥2.23 based on 2 Stage Free Cash Flow to Equity
• Aoyuan Beauty Valley TechnologyLtd's CN¥2.10 share price indicates it is trading at similar levels as its fair value estimate
• The average premium for Aoyuan Beauty Valley TechnologyLtd's competitorsis currently 1,303%

In this article we are going to estimate the intrinsic value of Aoyuan Beauty Valley Technology Co.,Ltd. (SZSE:000615) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Aoyuan Beauty Valley TechnologyLtd

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 begin with, we have to get estimates of 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥122.1m	CN¥133.1m	CN¥142.7m	CN¥151.1m	CN¥158.7m	CN¥165.6m	CN¥172.1m	CN¥178.3m	CN¥184.4m	CN¥190.4m
Growth Rate Estimate Source	Est @ 11.64%	Est @ 9.02%	Est @ 7.18%	Est @ 5.90%	Est @ 5.00%	Est @ 4.37%	Est @ 3.93%	Est @ 3.62%	Est @ 3.40%	Est @ 3.25%
Present Value (CN¥, Millions) Discounted @ 11%	CN¥110	CN¥108	CN¥104	CN¥98.7	CN¥93.1	CN¥87.4	CN¥81.6	CN¥76.0	CN¥70.7	CN¥65.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥894m

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 11%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥190m× (1 + 2.9%) ÷ (11%– 2.9%) = CN¥2.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥2.3b÷ ( 1 + 11%)¹⁰= CN¥809m

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¥1.7b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥2.1, the company appears about fair value at a 5.9% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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. 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 Aoyuan Beauty Valley TechnologyLtd 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 11%, which is based on a levered beta of 1.482. 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:

Whilst important, the DCF calculation 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. 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. 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 Aoyuan Beauty Valley TechnologyLtd, we've put together three additional aspects you should further examine:

1. Risks: Take risks, for example - Aoyuan Beauty Valley TechnologyLtd has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
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 Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.

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