A Look At The Intrinsic Value Of Lingyi iTech (Guangdong) Company (SZSE:002600)

Key Insights

• The projected fair value for Lingyi iTech (Guangdong) is CN¥8.38 based on 2 Stage Free Cash Flow to Equity
• Lingyi iTech (Guangdong)'s CN¥8.11 share price indicates it is trading at similar levels as its fair value estimate
• Our fair value estimate is 2.2% lower than Lingyi iTech (Guangdong)'s analyst price target of CN¥8.58

Does the October share price for Lingyi iTech (Guangdong) Company (SZSE:002600) 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. Our analysis will employ the Discounted Cash Flow (DCF) model. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Lingyi iTech (Guangdong)

The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. 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 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¥1.20b	CN¥1.73b	CN¥2.97b	CN¥3.39b	CN¥3.70b	CN¥3.97b	CN¥4.21b	CN¥4.43b	CN¥4.62b	CN¥4.80b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ 9.31%	Est @ 7.37%	Est @ 6.02%	Est @ 5.07%	Est @ 4.40%	Est @ 3.94%
Present Value (CN¥, Millions) Discounted @ 8.6%	CN¥1.1k	CN¥1.5k	CN¥2.3k	CN¥2.4k	CN¥2.4k	CN¥2.4k	CN¥2.4k	CN¥2.3k	CN¥2.2k	CN¥2.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥21b

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 8.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥4.8b× (1 + 2.9%) ÷ (8.6%– 2.9%) = CN¥86b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥86b÷ ( 1 + 8.6%)¹⁰= CN¥37b

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¥58b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥8.1, the company appears about fair value at a 3.3% 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Lingyi iTech (Guangdong) 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 8.6%, which is based on a levered beta of 1.160. 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 Lingyi iTech (Guangdong)

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Lingyi iTech (Guangdong), we've put together three relevant elements you should consider:

1. Risks: We feel that you should assess the 2 warning signs for Lingyi iTech (Guangdong) (1 is potentially serious!) we've flagged before making an investment in the company.
2. Future Earnings: How does 002600'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 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!

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.