Is Fujian Funeng Co., Ltd. (SHSE:600483) Trading At A 22% Discount?

Simply Wall St · 09/29 00:45

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Fujian Funeng fair value estimate is CN¥12.50
  • Fujian Funeng is estimated to be 22% undervalued based on current share price of CN¥9.74
  • Analyst price target for 600483 is CN¥11.96 which is 4.3% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Fujian Funeng Co., Ltd. (SHSE:600483) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Fujian Funeng

The Method

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 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (CN¥, Millions) CN¥1.90b CN¥1.78b CN¥1.71b CN¥1.69b CN¥1.68b CN¥1.69b CN¥1.72b CN¥1.75b CN¥1.78b CN¥1.82b
Growth Rate Estimate Source Analyst x1 Est @ -6.27% Est @ -3.53% Est @ -1.62% Est @ -0.28% Est @ 0.66% Est @ 1.32% Est @ 1.78% Est @ 2.10% Est @ 2.32%
Present Value (CN¥, Millions) Discounted @ 7.3% CN¥1.8k CN¥1.5k CN¥1.4k CN¥1.3k CN¥1.2k CN¥1.1k CN¥1.0k CN¥992 CN¥944 CN¥900

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥12b

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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CN¥1.8b× (1 + 2.9%) ÷ (7.3%– 2.9%) = CN¥42b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥42b÷ ( 1 + 7.3%)10= CN¥21b

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¥33b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥9.7, the company appears a touch undervalued at a 22% 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.

dcf
SHSE:600483 Discounted Cash Flow September 29th 2024

Important Assumptions

Now 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 Fujian Funeng 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 7.3%, which is based on a levered beta of 0.897. 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 Fujian Funeng

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
  • Dividend is in the top 25% of dividend payers in the market.
Weakness
  • Shareholders have been diluted in the past year.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to grow slower than the Chinese market.

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For Fujian Funeng, there are three relevant factors you should further examine:

  1. Risks: Take risks, for example - Fujian Funeng has 3 warning signs we think you should be aware of.
  2. Future Earnings: How does 600483'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 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SHSE every day. If you want to find the calculation for other stocks just search here.