Calculating The Fair Value Of Jiangxi Everbright Measurement And Control Technology Co.,Ltd. (SZSE:300906)

Key Insights

• Jiangxi Everbright Measurement And Control TechnologyLtd's estimated fair value is CN¥21.34 based on 2 Stage Free Cash Flow to Equity
• With CN¥22.91 share price, Jiangxi Everbright Measurement And Control TechnologyLtd appears to be trading close to its estimated fair value
• Jiangxi Everbright Measurement And Control TechnologyLtd's peers seem to be trading at a higher premium to fair value based onthe industry average of -466%

In this article we are going to estimate the intrinsic value of Jiangxi Everbright Measurement And Control Technology Co.,Ltd. (SZSE:300906) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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 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 Jiangxi Everbright Measurement And Control TechnologyLtd

What's The Estimated Valuation?

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

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥66.1m	CN¥80.1m	CN¥92.6m	CN¥103.5m	CN¥113.0m	CN¥121.2m	CN¥128.4m	CN¥134.9m	CN¥140.8m	CN¥146.4m
Growth Rate Estimate Source	Est @ 28.88%	Est @ 21.09%	Est @ 15.63%	Est @ 11.81%	Est @ 9.14%	Est @ 7.27%	Est @ 5.96%	Est @ 5.04%	Est @ 4.40%	Est @ 3.95%
Present Value (CN¥, Millions) Discounted @ 9.1%	CN¥60.6	CN¥67.3	CN¥71.4	CN¥73.2	CN¥73.2	CN¥72.0	CN¥70.0	CN¥67.4	CN¥64.5	CN¥61.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥681m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 9.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥146m× (1 + 2.9%) ÷ (9.1%– 2.9%) = CN¥2.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥2.4b÷ ( 1 + 9.1%)¹⁰= CN¥1.0b

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¥1.7b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥22.9, the company appears around fair value at the time of writing. 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. 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 Jiangxi Everbright Measurement And Control 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 9.1%, which is based on a levered beta of 1.095. 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.

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. 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 Jiangxi Everbright Measurement And Control TechnologyLtd, we've compiled three essential aspects you should further examine:

1. Risks: Case in point, we've spotted 3 warning signs for Jiangxi Everbright Measurement And Control TechnologyLtd you should be aware of, and 1 of them can't be ignored.
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 Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.