Stock Analysis

Calculating The Fair Value Of JD Logistics, Inc. (HKG:2618)

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SEHK:2618
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of JD Logistics, Inc. (HKG:2618) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

Check out our latest analysis for JD Logistics

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 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.

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) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (CN¥, Millions) CN¥1.92b CN¥3.60b CN¥4.42b CN¥5.14b CN¥5.75b CN¥6.26b CN¥6.67b CN¥7.01b CN¥7.29b CN¥7.53b
Growth Rate Estimate Source Analyst x6 Analyst x6 Est @ 22.8% Est @ 16.41% Est @ 11.93% Est @ 8.79% Est @ 6.6% Est @ 5.06% Est @ 3.99% Est @ 3.24%
Present Value (CN¥, Millions) Discounted @ 6.5% CN¥1.8k CN¥3.2k CN¥3.7k CN¥4.0k CN¥4.2k CN¥4.3k CN¥4.3k CN¥4.2k CN¥4.1k CN¥4.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥38b

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 6.5%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥7.5b× (1 + 1.5%) ÷ (6.5%– 1.5%) = CN¥152b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥152b÷ ( 1 + 6.5%)10= CN¥81b

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¥119b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$28.0, 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.

dcf
SEHK:2618 Discounted Cash Flow December 12th 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. 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 JD Logistics 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 6.5%, which is based on a levered beta of 1.012. 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.

Next Steps:

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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For JD Logistics, there are three essential factors you should look at:

  1. Risks: Be aware that JD Logistics is showing 2 warning signs in our investment analysis , you should know about...
  2. Future Earnings: How does 2618'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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