Eastern Air Logistics Co., Ltd.'s (SHSE:601156) Intrinsic Value Is Potentially 71% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Eastern Air Logistics fair value estimate is CN¥28.44
• Eastern Air Logistics' CN¥16.59 share price signals that it might be 42% undervalued
• The CN¥23.55 analyst price target for 601156 is 17% less than our estimate of fair value

How far off is Eastern Air Logistics Co., Ltd. (SHSE:601156) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 Eastern Air Logistics

The Model

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. 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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥2.97b	CN¥2.92b	CN¥2.90b	CN¥2.92b	CN¥2.96b	CN¥3.01b	CN¥3.07b	CN¥3.14b	CN¥3.22b	CN¥3.31b
Growth Rate Estimate Source	Est @ -3.93%	Est @ -1.88%	Est @ -0.45%	Est @ 0.56%	Est @ 1.26%	Est @ 1.75%	Est @ 2.10%	Est @ 2.34%	Est @ 2.51%	Est @ 2.62%
Present Value (CN¥, Millions) Discounted @ 8.7%	CN¥2.7k	CN¥2.5k	CN¥2.3k	CN¥2.1k	CN¥1.9k	CN¥1.8k	CN¥1.7k	CN¥1.6k	CN¥1.5k	CN¥1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥20b

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 (2.9%) 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 8.7%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥3.3b× (1 + 2.9%) ÷ (8.7%– 2.9%) = CN¥59b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥59b÷ ( 1 + 8.7%)¹⁰= CN¥26b

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¥45b. 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¥16.6, the company appears quite undervalued at a 42% 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

We would point out that 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 Eastern Air Logistics 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 1.029. 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 Eastern Air Logistics

Looking Ahead:

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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Eastern Air Logistics, we've compiled three additional elements you should consider:

1. Financial Health: Does 601156 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does 601156'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 SHSE 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com