Calculating The Intrinsic Value Of Tongding Interconnection Information Co., Ltd. (SZSE:002491)

Key Insights

• The projected fair value for Tongding Interconnection Information is CN¥4.28 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥4.61 suggests Tongding Interconnection Information is potentially trading close to its fair value
• When compared to theindustry average discount of -252%, Tongding Interconnection Information's competitors seem to be trading at a greater premium to fair value

In this article we are going to estimate the intrinsic value of Tongding Interconnection Information Co., Ltd. (SZSE:002491) 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. 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. 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 Tongding Interconnection Information

Crunching The Numbers

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. 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥271.0m	CN¥299.0m	CN¥323.4m	CN¥344.6m	CN¥363.5m	CN¥380.7m	CN¥396.6m	CN¥411.8m	CN¥426.4m	CN¥440.8m
Growth Rate Estimate Source	Est @ 13.54%	Est @ 10.36%	Est @ 8.13%	Est @ 6.58%	Est @ 5.49%	Est @ 4.72%	Est @ 4.19%	Est @ 3.81%	Est @ 3.55%	Est @ 3.37%
Present Value (CN¥, Millions) Discounted @ 9.2%	CN¥248	CN¥251	CN¥248	CN¥243	CN¥234	CN¥225	CN¥214	CN¥204	CN¥193	CN¥183

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥2.2b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.9%. 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¥441m× (1 + 2.9%) ÷ (9.2%– 2.9%) = CN¥7.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥7.3b÷ ( 1 + 9.2%)¹⁰= CN¥3.0b

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¥5.3b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥4.6, the company appears around fair value at the time of writing. 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Tongding Interconnection Information 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 1.109. 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 Tongding Interconnection Information

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. For Tongding Interconnection Information, we've put together three additional aspects you should consider:

1. Risks: As an example, we've found 1 warning sign for Tongding Interconnection Information that you need to consider before investing here.
2. 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!
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.

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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.