ZTO Express (Cayman) Inc. (NYSE:ZTO) Shares Could Be 45% Below Their Intrinsic Value Estimate

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, ZTO Express (Cayman) fair value estimate is US$45.00
• Current share price of US$24.77 suggests ZTO Express (Cayman) is potentially 45% undervalued
• Our fair value estimate is 53% higher than ZTO Express (Cayman)'s analyst price target of CN¥29.38

How far off is ZTO Express (Cayman) Inc. (NYSE:ZTO) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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 ZTO Express (Cayman)

The Model

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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¥10.3b	CN¥11.2b	CN¥11.9b	CN¥12.5b	CN¥13.1b	CN¥13.6b	CN¥14.1b	CN¥14.5b	CN¥14.9b	CN¥15.3b
Growth Rate Estimate Source	Analyst x6	Analyst x6	Est @ 6.37%	Est @ 5.21%	Est @ 4.40%	Est @ 3.83%	Est @ 3.43%	Est @ 3.15%	Est @ 2.96%	Est @ 2.82%
Present Value (CN¥, Millions) Discounted @ 7.2%	CN¥9.6k	CN¥9.8k	CN¥9.7k	CN¥9.5k	CN¥9.3k	CN¥9.0k	CN¥8.7k	CN¥8.3k	CN¥8.0k	CN¥7.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥89b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥15b× (1 + 2.5%) ÷ (7.2%– 2.5%) = CN¥337b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥337b÷ ( 1 + 7.2%)¹⁰= CN¥168b

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¥258b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$24.8, the company appears quite undervalued at a 45% 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.

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. 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 7.2%, which is based on a levered beta of 0.938. 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 ZTO Express (Cayman)

Moving On:

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. 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. Why is the intrinsic value higher than the current share price? For ZTO Express (Cayman), we've put together three important aspects you should explore:

1. Risks: We feel that you should assess the 1 warning sign for ZTO Express (Cayman) we've flagged before making an investment in the company.
2. 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.
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 NYSE every day. If you want to find the calculation for other stocks 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.