A Look At The Fair Value Of Jiangsu Innovative Ecological New Materials Limited (HKG:2116)

Key Insights

• The projected fair value for Jiangsu Innovative Ecological New Materials is HK$0.34 based on 2 Stage Free Cash Flow to Equity
• Jiangsu Innovative Ecological New Materials' HK$0.40 share price indicates it is trading at similar levels as its fair value estimate
• When compared to theindustry average discount of -488%, Jiangsu Innovative Ecological New Materials' competitors seem to be trading at a greater premium to fair value

How far off is Jiangsu Innovative Ecological New Materials Limited (HKG:2116) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Jiangsu Innovative Ecological New Materials

What's The Estimated Valuation?

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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥10.8m	CN¥9.81m	CN¥9.26m	CN¥8.95m	CN¥8.80m	CN¥8.75m	CN¥8.77m	CN¥8.84m	CN¥8.94m	CN¥9.06m
Growth Rate Estimate Source	Est @ -13.53%	Est @ -8.86%	Est @ -5.59%	Est @ -3.30%	Est @ -1.70%	Est @ -0.58%	Est @ 0.21%	Est @ 0.76%	Est @ 1.14%	Est @ 1.41%
Present Value (CN¥, Millions) Discounted @ 7.4%	CN¥10.0	CN¥8.5	CN¥7.5	CN¥6.7	CN¥6.2	CN¥5.7	CN¥5.3	CN¥5.0	CN¥4.7	CN¥4.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥64m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥9.1m× (1 + 2.0%) ÷ (7.4%– 2.0%) = CN¥173m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥173m÷ ( 1 + 7.4%)¹⁰= CN¥85m

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¥149m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Jiangsu Innovative Ecological New Materials 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 7.4%, which is based on a levered beta of 0.951. 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:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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?" 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 Jiangsu Innovative Ecological New Materials, we've put together three essential elements you should further examine:

1. Risks: We feel that you should assess the 2 warning signs for Jiangsu Innovative Ecological New Materials (1 can't be ignored!) we've flagged before making 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.