Calculating The Fair Value Of Shanghai Lingyun Industries Development Co., Ltd (SHSE:900957)

Key Insights

• Shanghai Lingyun Industries Development's estimated fair value is US$0.17 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$0.21 suggests Shanghai Lingyun Industries Development is potentially trading close to its fair value
• When compared to theindustry average discount of -419%, Shanghai Lingyun Industries Development's competitors seem to be trading at a greater premium to fair value

Does the May share price for Shanghai Lingyun Industries Development Co., Ltd (SHSE:900957) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Shanghai Lingyun Industries Development

The Calculation

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 start off with, we need to estimate 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥37.2m	CN¥31.2m	CN¥27.9m	CN¥26.0m	CN¥25.1m	CN¥24.6m	CN¥24.6m	CN¥24.7m	CN¥25.0m	CN¥25.5m
Growth Rate Estimate Source	Est @ -24.59%	Est @ -16.34%	Est @ -10.57%	Est @ -6.53%	Est @ -3.70%	Est @ -1.72%	Est @ -0.33%	Est @ 0.64%	Est @ 1.32%	Est @ 1.79%
Present Value (CN¥, Millions) Discounted @ 7.8%	CN¥34.5	CN¥26.8	CN¥22.2	CN¥19.3	CN¥17.2	CN¥15.7	CN¥14.5	CN¥13.5	CN¥12.7	CN¥12.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥189m

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. 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 7.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥25m× (1 + 2.9%) ÷ (7.8%– 2.9%) = CN¥535m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥535m÷ ( 1 + 7.8%)¹⁰= CN¥252m

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¥441m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$0.2, the company appears around fair value at the time of writing. 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

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 Shanghai Lingyun Industries Development 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 7.8%, which is based on a levered beta of 0.872. 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 Shanghai Lingyun Industries Development

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Shanghai Lingyun Industries Development, there are three additional factors you should explore:

1. Risks: For instance, we've identified 3 warning signs for Shanghai Lingyun Industries Development (1 is significant) you should be aware of.
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 SHSE every day. If you want to find the calculation for other stocks just search here.

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

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.