A Look At The Intrinsic Value Of Zhengwei Group Holdings Company Limited (HKG:2147)

Key Insights

• Zhengwei Group Holdings' estimated fair value is HK$1.64 based on 2 Stage Free Cash Flow to Equity
• With HK$1.86 share price, Zhengwei Group Holdings appears to be trading close to its estimated fair value
• Zhengwei Group Holdings' peers are currently trading at a discount of 25% on average

In this article we are going to estimate the intrinsic value of Zhengwei Group Holdings Company Limited (HKG:2147) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Zhengwei Group Holdings

The Method

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥74.7m	CN¥73.8m	CN¥73.5m	CN¥73.8m	CN¥74.3m	CN¥75.1m	CN¥76.1m	CN¥77.2m	CN¥78.4m	CN¥79.6m
Growth Rate Estimate Source	Est @ -2.57%	Est @ -1.26%	Est @ -0.34%	Est @ 0.30%	Est @ 0.75%	Est @ 1.07%	Est @ 1.29%	Est @ 1.44%	Est @ 1.55%	Est @ 1.62%
Present Value (CN¥, Millions) Discounted @ 7.5%	CN¥69.5	CN¥63.8	CN¥59.1	CN¥55.2	CN¥51.7	CN¥48.6	CN¥45.8	CN¥43.2	CN¥40.8	CN¥38.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥516m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥80m× (1 + 1.8%) ÷ (7.5%– 1.8%) = CN¥1.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥1.4b÷ ( 1 + 7.5%)¹⁰= CN¥685m

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¥1.2b. 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$1.9, 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.

Important 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. 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 Zhengwei Group Holdings 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 7.5%, which is based on a levered beta of 0.800. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Zhengwei Group Holdings, we've compiled three fundamental elements you should explore:

1. Risks: For example, we've discovered 1 warning sign for Zhengwei Group Holdings that you should be aware of before investing here.
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 Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.