Are Investors Undervaluing Anhui Jinhe Industrial Co.,Ltd. (SZSE:002597) By 30%?

Simply Wall St · 09/29 01:19

Key Insights

  • Anhui Jinhe IndustrialLtd's estimated fair value is CN¥33.07 based on 2 Stage Free Cash Flow to Equity
  • Anhui Jinhe IndustrialLtd is estimated to be 30% undervalued based on current share price of CN¥23.09
  • Our fair value estimate is 26% higher than Anhui Jinhe IndustrialLtd's analyst price target of CN¥26.23

Does the September share price for Anhui Jinhe Industrial Co.,Ltd. (SZSE:002597) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Anhui Jinhe IndustrialLtd

Is Anhui Jinhe IndustrialLtd Fairly Valued?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (CN¥, Millions) CN¥421.0m CN¥585.0m CN¥712.9m CN¥828.1m CN¥928.9m CN¥1.02b CN¥1.09b CN¥1.16b CN¥1.22b CN¥1.27b
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 21.86% Est @ 16.16% Est @ 12.17% Est @ 9.37% Est @ 7.42% Est @ 6.05% Est @ 5.09% Est @ 4.42%
Present Value (CN¥, Millions) Discounted @ 7.8% CN¥390 CN¥503 CN¥568 CN¥612 CN¥637 CN¥646 CN¥643 CN¥633 CN¥617 CN¥597

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥5.8b

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 (2.9%) 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 7.8%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CN¥1.3b× (1 + 2.9%) ÷ (7.8%– 2.9%) = CN¥26b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥26b÷ ( 1 + 7.8%)10= CN¥12b

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¥18b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥23.1, the company appears quite undervalued at a 30% 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
SZSE:002597 Discounted Cash Flow September 29th 2024

The 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. 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 Anhui Jinhe IndustrialLtd 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 7.8%, which is based on a levered beta of 1.002. 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 Anhui Jinhe IndustrialLtd

Strength
  • Debt is not viewed as a risk.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Chemicals market.
Opportunity
  • Annual earnings are forecast to grow faster than the Chinese market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Paying a dividend but company has no free cash flows.
  • Revenue is forecast to grow slower than 20% per year.

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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Anhui Jinhe IndustrialLtd, we've put together three additional factors you should further research:

  1. Risks: To that end, you should learn about the 3 warning signs we've spotted with Anhui Jinhe IndustrialLtd (including 1 which doesn't sit too well with us) .
  2. Future Earnings: How does 002597'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 Chinese stock every day, so if you want to find the intrinsic value of any other stock just search here.