Estimating The Intrinsic Value Of China Tianrui Automotive Interiors Co., LTD (HKG:6162)

Key Insights

• China Tianrui Automotive Interiors' estimated fair value is HK$0.072 based on 2 Stage Free Cash Flow to Equity
• With HK$0.086 share price, China Tianrui Automotive Interiors appears to be trading close to its estimated fair value
• Industry average of 953% suggests China Tianrui Automotive Interiors' peers are currently trading at a higher premium to fair value

Does the November share price for China Tianrui Automotive Interiors Co., LTD (HKG:6162) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. Our analysis will employ 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for China Tianrui Automotive Interiors

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥14.1m	CN¥12.3m	CN¥11.3m	CN¥10.7m	CN¥10.4m	CN¥10.2m	CN¥10.2m	CN¥10.3m	CN¥10.4m	CN¥10.5m
Growth Rate Estimate Source	Est @ -19.29%	Est @ -12.83%	Est @ -8.31%	Est @ -5.14%	Est @ -2.92%	Est @ -1.37%	Est @ -0.28%	Est @ 0.48%	Est @ 1.01%	Est @ 1.38%
Present Value (CN¥, Millions) Discounted @ 9.5%	CN¥12.9	CN¥10.3	CN¥8.6	CN¥7.4	CN¥6.6	CN¥5.9	CN¥5.4	CN¥5.0	CN¥4.6	CN¥4.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥71m

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 (2.3%) 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 9.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥10m× (1 + 2.3%) ÷ (9.5%– 2.3%) = CN¥149m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥149m÷ ( 1 + 9.5%)¹⁰= CN¥60m

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¥131m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$0.09, 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.

Important 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 China Tianrui Automotive Interiors 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 9.5%, which is based on a levered beta of 1.450. 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.

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For China Tianrui Automotive Interiors, we've put together three fundamental elements you should further research:

1. Risks: You should be aware of the 2 warning signs for China Tianrui Automotive Interiors (1 is a bit unpleasant!) we've uncovered before considering an investment in the company.
2. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
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 SEHK 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.