Calculating The Fair Value Of Chengdu Galaxy Magnets Co.,Ltd. (SZSE:300127)

Key Insights

• Chengdu Galaxy MagnetsLtd's estimated fair value is CN¥28.15 based on 2 Stage Free Cash Flow to Equity
• With CN¥26.76 share price, Chengdu Galaxy MagnetsLtd appears to be trading close to its estimated fair value
• Peers of Chengdu Galaxy MagnetsLtd are currently trading on average at a 2,310% premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Chengdu Galaxy Magnets Co.,Ltd. (SZSE:300127) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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 Chengdu Galaxy MagnetsLtd

The Calculation

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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥327.4m	CN¥386.8m	CN¥439.2m	CN¥484.5m	CN¥523.5m	CN¥557.5m	CN¥587.5m	CN¥614.5m	CN¥639.5m	CN¥663.0m
Growth Rate Estimate Source	Est @ 24.72%	Est @ 18.14%	Est @ 13.54%	Est @ 10.32%	Est @ 8.06%	Est @ 6.48%	Est @ 5.38%	Est @ 4.61%	Est @ 4.06%	Est @ 3.68%
Present Value (CN¥, Millions) Discounted @ 8.2%	CN¥303	CN¥331	CN¥347	CN¥354	CN¥353	CN¥348	CN¥339	CN¥328	CN¥315	CN¥302

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥3.3b

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 (2.8%) 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 8.2%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥663m× (1 + 2.8%) ÷ (8.2%– 2.8%) = CN¥13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥13b÷ ( 1 + 8.2%)¹⁰= CN¥5.8b

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¥9.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CN¥26.8, the company appears about fair value at a 4.9% discount to where the stock price trades currently. 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.

The Assumptions

Now 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 Chengdu Galaxy MagnetsLtd 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 8.2%, which is based on a levered beta of 1.079. 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 Chengdu Galaxy MagnetsLtd

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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 Chengdu Galaxy MagnetsLtd, we've put together three additional items you should consider:

1. Risks: For example, we've discovered 2 warning signs for Chengdu Galaxy MagnetsLtd (1 doesn't sit too well with us!) that you should be aware of before investing here.
2. Future Earnings: How does 300127'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SZSE every day. If you want to find the calculation for other stocks 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.