Calculating The Intrinsic Value Of Jiangsu Innovative Ecological New Materials Limited (HKG:2116)

Key Insights

• Jiangsu Innovative Ecological New Materials' estimated fair value is HK$0.32 based on 2 Stage Free Cash Flow to Equity
• With HK$0.36 share price, Jiangsu Innovative Ecological New Materials appears to be trading close to its estimated fair value
• When compared to theindustry average discount of -41%, Jiangsu Innovative Ecological New Materials' competitors seem to be trading at a greater premium to fair value

In this article we are going to estimate the intrinsic value of Jiangsu Innovative Ecological New Materials Limited (HKG:2116) 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 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.

Check out our latest analysis for Jiangsu Innovative Ecological New Materials

Is Jiangsu Innovative Ecological New Materials Fairly Valued?

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. 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¥10.8m	CN¥9.79m	CN¥9.24m	CN¥8.92m	CN¥8.76m	CN¥8.69m	CN¥8.70m	CN¥8.75m	CN¥8.84m	CN¥8.95m
Growth Rate Estimate Source	Est @ -13.58%	Est @ -8.94%	Est @ -5.70%	Est @ -3.42%	Est @ -1.83%	Est @ -0.72%	Est @ 0.06%	Est @ 0.61%	Est @ 0.99%	Est @ 1.26%
Present Value (CN¥, Millions) Discounted @ 7.5%	CN¥10.0	CN¥8.5	CN¥7.4	CN¥6.7	CN¥6.1	CN¥5.6	CN¥5.3	CN¥4.9	CN¥4.6	CN¥4.4

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

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.9%) 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 7.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥9.0m× (1 + 1.9%) ÷ (7.5%– 1.9%) = CN¥164m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥164m÷ ( 1 + 7.5%)¹⁰= CN¥80m

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¥143m. 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$0.4, 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 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 7.5%, which is based on a levered beta of 0.918. 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. 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 Jiangsu Innovative Ecological New Materials, we've compiled three relevant aspects you should further examine:

1. Risks: Every company has them, and we've spotted 2 warning signs for Jiangsu Innovative Ecological New Materials (of which 1 is concerning!) you should know about.
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.