Zijin Mining Group Company Limited's (HKG:2899) Intrinsic Value Is Potentially 70% Above Its Share Price

By
Simply Wall St
Published
April 01, 2021
SEHK:2899

Does the April share price for Zijin Mining Group Company Limited (HKG:2899) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present 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.

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 Zijin Mining Group

The model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (CN¥, Millions) CN¥10.3b CN¥22.2b CN¥25.5b CN¥27.9b CN¥29.9b CN¥31.5b CN¥32.8b CN¥33.9b CN¥34.9b CN¥35.7b
Growth Rate Estimate Source Analyst x3 Analyst x4 Analyst x1 Est @ 9.39% Est @ 7.02% Est @ 5.37% Est @ 4.21% Est @ 3.4% Est @ 2.83% Est @ 2.44%
Present Value (CN¥, Millions) Discounted @ 9.3% CN¥9.4k CN¥18.6k CN¥19.5k CN¥19.5k CN¥19.1k CN¥18.4k CN¥17.6k CN¥16.6k CN¥15.6k CN¥14.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥169b

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 9.3%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = CN¥36b× (1 + 1.5%) ÷ (9.3%– 1.5%) = CN¥463b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥463b÷ ( 1 + 9.3%)10= CN¥190b

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¥359b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$9.8, the company appears quite undervalued at a 41% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
SEHK:2899 Discounted Cash Flow April 2nd 2021

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Zijin Mining Group 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 9.3%, which is based on a levered beta of 1.250. 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:

Whilst important, the DCF calculation 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Zijin Mining Group, there are three further factors you should assess:

  1. Risks: For example, we've discovered 2 warning signs for Zijin Mining Group (1 is a bit concerning!) that you should be aware of before investing here.
  2. Future Earnings: How does 2899'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 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!

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. 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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