Zijin Mining Group Company Limited's (HKG:2899) Intrinsic Value Is Potentially 83% Above Its Share Price

In this article we are going to estimate the intrinsic value of Zijin Mining Group Company Limited (HKG:2899) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out the opportunities and risks within the HK Metals and Mining industry.

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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥23.9b	CN¥28.7b	CN¥32.2b	CN¥35.1b	CN¥37.5b	CN¥39.4b	CN¥41.1b	CN¥42.5b	CN¥43.7b	CN¥44.8b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Est @ 12.14%	Est @ 8.98%	Est @ 6.77%	Est @ 5.23%	Est @ 4.14%	Est @ 3.39%	Est @ 2.86%	Est @ 2.49%
Present Value (CN¥, Millions) Discounted @ 9.4%	CN¥21.9k	CN¥24.0k	CN¥24.6k	CN¥24.5k	CN¥23.9k	CN¥23.0k	CN¥21.9k	CN¥20.7k	CN¥19.5k	CN¥18.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥222b

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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 9.4%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥45b× (1 + 1.6%) ÷ (9.4%– 1.6%) = CN¥585b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥585b÷ ( 1 + 9.4%)¹⁰= CN¥238b

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¥461b. 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$10.6, the company appears quite undervalued at a 45% discount to where the stock price trades currently. 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.

Important 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 9.4%, which is based on a levered beta of 1.302. 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:

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. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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, we've compiled three relevant elements you should consider:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Zijin Mining Group , and understanding it should be part of your investment process.
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. 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.

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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.