Stock Analysis

Are Investors Undervaluing China Mengniu Dairy Company Limited (HKG:2319) By 34%?

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SEHK:2319
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Today we will run through one way of estimating the intrinsic value of China Mengniu Dairy Company Limited (HKG:2319) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. 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 China Mengniu Dairy

Crunching The Numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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, 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) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (CN¥, Millions) CN¥3.77b CN¥5.78b CN¥5.47b CN¥6.16b CN¥6.66b CN¥7.06b CN¥7.40b CN¥7.68b CN¥7.92b CN¥8.13b
Growth Rate Estimate Source Analyst x9 Analyst x9 Analyst x1 Analyst x1 Est @ 8.07% Est @ 6.11% Est @ 4.74% Est @ 3.78% Est @ 3.11% Est @ 2.65%
Present Value (CN¥, Millions) Discounted @ 5.4% CN¥3.6k CN¥5.2k CN¥4.7k CN¥5.0k CN¥5.1k CN¥5.1k CN¥5.1k CN¥5.0k CN¥4.9k CN¥4.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥49b

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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 5.4%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CN¥8.1b× (1 + 1.6%) ÷ (5.4%– 1.6%) = CN¥213b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥213b÷ ( 1 + 5.4%)10= CN¥126b

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¥174b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$31.9, the company appears quite good value at a 34% discount to where the stock price trades currently. 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.

dcf
SEHK:2319 Discounted Cash Flow September 29th 2022

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Mengniu Dairy 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 5.4%, 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:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For China Mengniu Dairy, we've compiled three further factors you should look at:

  1. Risks: Case in point, we've spotted 1 warning sign for China Mengniu Dairy you should be aware of.
  2. Future Earnings: How does 2319'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 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!

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.

Valuation is complex, but we're helping make it simple.

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About SEHK:2319

China Mengniu Dairy

China Mengniu Dairy Company Limited, an investment holding company, produces and distributes dairy products in the People’s Republic of China and internationally.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation3
Future Growth2
Past Performance4
Financial Health3
Dividends0

Read more about these checks in the individual report sections or in our analysis model.

Proven track record and fair value.