Estimating The Fair Value Of Lingyi iTech (Guangdong) Company (SZSE:002600)

Key Insights

• Lingyi iTech (Guangdong)'s estimated fair value is CN¥10.22 based on 2 Stage Free Cash Flow to Equity
• Lingyi iTech (Guangdong)'s CN¥8.51 share price indicates it is trading at similar levels as its fair value estimate
• Our fair value estimate is 6.4% higher than Lingyi iTech (Guangdong)'s analyst price target of CN¥9.60

Today we will run through one way of estimating the intrinsic value of Lingyi iTech (Guangdong) Company (SZSE:002600) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

View our latest analysis for Lingyi iTech (Guangdong)

Is Lingyi iTech (Guangdong) Fairly Valued?

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. 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.

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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥823.0m	CN¥1.29b	CN¥2.89b	CN¥3.59b	CN¥4.27b	CN¥4.79b	CN¥5.23b	CN¥5.61b	CN¥5.95b	CN¥6.24b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ 12.00%	Est @ 9.24%	Est @ 7.31%	Est @ 5.95%	Est @ 5.01%
Present Value (CN¥, Millions) Discounted @ 8.7%	CN¥757	CN¥1.1k	CN¥2.3k	CN¥2.6k	CN¥2.8k	CN¥2.9k	CN¥2.9k	CN¥2.9k	CN¥2.8k	CN¥2.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥24b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.8%) 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 8.7%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥6.2b× (1 + 2.8%) ÷ (8.7%– 2.8%) = CN¥109b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥109b÷ ( 1 + 8.7%)¹⁰= CN¥48b

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¥71b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥8.5, the company appears about fair value at a 17% 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

Now 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 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 8.7%, which is based on a levered beta of 1.179. 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:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Lingyi iTech (Guangdong), we've compiled three further factors you should further research:

1. Risks: Every company has them, and we've spotted 1 warning sign for Lingyi iTech (Guangdong) you should know about.
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.