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An Intrinsic Calculation For ZTO Express (Cayman) Inc. (NYSE:ZTO) Suggests It's 21% Undervalued
In this article we are going to estimate the intrinsic value of ZTO Express (Cayman) Inc. (NYSE:ZTO) 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.
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.
Check out our latest analysis for ZTO Express (Cayman)
The calculation
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.
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) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Levered FCF (CN¥, Millions) | CN¥2.73b | CN¥5.17b | CN¥7.18b | CN¥7.88b | CN¥8.62b | CN¥9.17b | CN¥9.62b | CN¥10.0b | CN¥10.4b | CN¥10.7b |
Growth Rate Estimate Source | Analyst x7 | Analyst x7 | Analyst x6 | Analyst x1 | Analyst x1 | Est @ 6.32% | Est @ 5% | Est @ 4.08% | Est @ 3.43% | Est @ 2.98% |
Present Value (CN¥, Millions) Discounted @ 6.8% | CN¥2.6k | CN¥4.5k | CN¥5.9k | CN¥6.1k | CN¥6.2k | CN¥6.2k | CN¥6.1k | CN¥5.9k | CN¥5.7k | CN¥5.5k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥55b
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. 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 6.8%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥11b× (1 + 1.9%) ÷ (6.8%– 1.9%) = CN¥224b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥224b÷ ( 1 + 6.8%)10= CN¥116b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥171b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$24.7, the company appears a touch undervalued at a 21% 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.
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 ZTO Express (Cayman) 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 6.8%, which is based on a levered beta of 0.984. 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. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For ZTO Express (Cayman), we've compiled three additional aspects you should consider:
- Financial Health: Does ZTO have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does ZTO'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.
- 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!
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.
Valuation is complex, but we're here to simplify it.
Discover if ZTO Express (Cayman) might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
About NYSE:ZTO
ZTO Express (Cayman)
Provides express delivery and other value-added logistics services in the People's Republic of China.
Undervalued with excellent balance sheet.