Zhaojin Mining Industry Company Limited (HKG:1818) Shares Could Be 26% Below Their Intrinsic Value Estimate

Key Insights

• Zhaojin Mining Industry's estimated fair value is CN¥12.3 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥9.1 suggests Zhaojin Mining Industry is 26% undervalued
• Analyst price target for 1818 is CN¥8.76 which is 29% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Zhaojin Mining Industry Company Limited (HKG:1818) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using 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.

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 Zhaojin Mining Industry

The Method

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥740.0m	CN¥1.47b	CN¥2.10b	CN¥2.74b	CN¥3.34b	CN¥3.87b	CN¥4.31b	CN¥4.68b	CN¥4.98b	CN¥5.23b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 42.90%	Est @ 30.52%	Est @ 21.85%	Est @ 15.78%	Est @ 11.53%	Est @ 8.56%	Est @ 6.48%	Est @ 5.02%
Present Value (CN¥, Millions) Discounted @ 12%	CN¥664	CN¥1.2k	CN¥1.5k	CN¥1.8k	CN¥1.9k	CN¥2.0k	CN¥2.0k	CN¥2.0k	CN¥1.9k	CN¥1.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥17b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (1.6%) 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 12%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥5.2b× (1 + 1.6%) ÷ (12%– 1.6%) = CN¥54b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥54b÷ ( 1 + 12%)¹⁰= CN¥18b

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¥35b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$9.1, the company appears a touch undervalued at a 26% 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.

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 Zhaojin Mining Industry 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 12%, which is based on a levered beta of 1.415. 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 Zhaojin Mining Industry

Moving On:

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. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. Why is the intrinsic value higher than the current share price? For Zhaojin Mining Industry, we've put together three essential items you should explore:

1. Risks: As an example, we've found 2 warning signs for Zhaojin Mining Industry (1 doesn't sit too well with us!) that you need to consider before investing here.
2. Future Earnings: How does 1818'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. 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.