A Look At The Intrinsic Value Of ATA Creativity Global (NASDAQ:AACG)

Key Insights

• The projected fair value for ATA Creativity Global is US$0.59 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$0.67 suggests ATA Creativity Global is potentially trading close to its fair value
• When compared to theindustry average discount of -16%, ATA Creativity Global's competitors seem to be trading at a greater premium to fair value

In this article we are going to estimate the intrinsic value of ATA Creativity Global (NASDAQ:AACG) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 ATA Creativity Global

The Method

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥6.35m	CN¥6.76m	CN¥7.11m	CN¥7.42m	CN¥7.69m	CN¥7.95m	CN¥8.19m	CN¥8.43m	CN¥8.65m	CN¥8.88m
Growth Rate Estimate Source	Est @ 8.07%	Est @ 6.36%	Est @ 5.17%	Est @ 4.33%	Est @ 3.75%	Est @ 3.34%	Est @ 3.05%	Est @ 2.85%	Est @ 2.71%	Est @ 2.61%
Present Value (CN¥, Millions) Discounted @ 7.6%	CN¥5.9	CN¥5.8	CN¥5.7	CN¥5.5	CN¥5.3	CN¥5.1	CN¥4.9	CN¥4.7	CN¥4.5	CN¥4.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥52m

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥8.9m× (1 + 2.4%) ÷ (7.6%– 2.4%) = CN¥174m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥174m÷ ( 1 + 7.6%)¹⁰= CN¥83m

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¥135m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$0.7, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 ATA Creativity Global 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 7.6%, which is based on a levered beta of 0.931. 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.

SWOT Analysis for ATA Creativity Global

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For ATA Creativity Global, we've compiled three additional elements you should explore:

1. Risks: For instance, we've identified 1 warning sign for ATA Creativity Global that you should be aware of.
2. 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!
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. Simply Wall St updates its DCF calculation for every American 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com