Estimating The Intrinsic Value Of Yantai North Andre Juice Company Limited (HKG:2218)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Yantai North Andre Juice Company Limited (HKG:2218) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Yantai North Andre Juice

The model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

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) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (CN¥, Millions)	CN¥138.9m	CN¥124.9m	CN¥116.6m	CN¥111.8m	CN¥109.0m	CN¥107.6m	CN¥107.2m	CN¥107.3m	CN¥107.9m	CN¥108.8m
Growth Rate Estimate Source	Est @ -15.05%	Est @ -10.08%	Est @ -6.6%	Est @ -4.17%	Est @ -2.46%	Est @ -1.27%	Est @ -0.44%	Est @ 0.15%	Est @ 0.56%	Est @ 0.84%
Present Value (CN¥, Millions) Discounted @ 6.5%	CN¥130	CN¥110	CN¥96.5	CN¥86.8	CN¥79.5	CN¥73.7	CN¥68.9	CN¥64.8	CN¥61.1	CN¥57.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥829m

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 6.5%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = CN¥109m× (1 + 1.5%) ÷ (6.5%– 1.5%) = CN¥2.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥2.2b÷ ( 1 + 6.5%)¹⁰= CN¥1.2b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥2.0b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$7.3, 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

Now 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 Yantai North Andre Juice 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 6.5%, 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.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 Yantai North Andre Juice, we've compiled three pertinent items you should further research:

1. Risks: Take risks, for example - Yantai North Andre Juice has 2 warning signs we think 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. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. 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.
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