FangDa Carbon New Material Co.,Ltd (SHSE:600516) Shares Could Be 40% Below Their Intrinsic Value Estimate

Key Insights

• FangDa Carbon New MaterialLtd's estimated fair value is CN¥8.62 based on 2 Stage Free Cash Flow to Equity
• FangDa Carbon New MaterialLtd's CN¥5.14 share price signals that it might be 40% undervalued
• The CN¥5.40 analyst price target for 600516 is 37% less than our estimate of fair value

How far off is FangDa Carbon New Material Co.,Ltd (SHSE:600516) 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 forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. 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.

Check out our latest analysis for FangDa Carbon New MaterialLtd

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. 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.

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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥846.5m	CN¥1.13b	CN¥1.41b	CN¥1.67b	CN¥1.90b	CN¥2.09b	CN¥2.26b	CN¥2.41b	CN¥2.54b	CN¥2.65b
Growth Rate Estimate Source	Est @ 47.46%	Est @ 34.06%	Est @ 24.68%	Est @ 18.12%	Est @ 13.52%	Est @ 10.31%	Est @ 8.05%	Est @ 6.48%	Est @ 5.37%	Est @ 4.60%
Present Value (CN¥, Millions) Discounted @ 8.4%	CN¥781	CN¥966	CN¥1.1k	CN¥1.2k	CN¥1.3k	CN¥1.3k	CN¥1.3k	CN¥1.3k	CN¥1.2k	CN¥1.2k

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

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥2.7b× (1 + 2.8%) ÷ (8.4%– 2.8%) = CN¥49b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥49b÷ ( 1 + 8.4%)¹⁰= CN¥22b

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¥33b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥5.1, the company appears quite good value at a 40% 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

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 FangDa Carbon New MaterialLtd 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 8.4%, which is based on a levered beta of 1.125. 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 FangDa Carbon New MaterialLtd

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. 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. Can we work out why the company is trading at a discount to intrinsic value? For FangDa Carbon New MaterialLtd, we've put together three important elements you should consider:

1. Risks: Case in point, we've spotted 3 warning signs for FangDa Carbon New MaterialLtd you should be aware of.
2. Future Earnings: How does 600516'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.

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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.