Home Discount rate The intrinsic value of Jiangxi Copper Company Limited (HKG: 358) is potentially 93% higher than its share price

The intrinsic value of Jiangxi Copper Company Limited (HKG: 358) is potentially 93% higher than its share price

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How far is Jiangxi Copper Company Limited (HKG:358) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the expected future cash flows and discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to do, although it may seem quite complex.

We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.

See our latest analysis for Jiangxi Copper

The calculation

We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:

10-Year Free Cash Flow (FCF) Forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF (CN¥, Million) -CN¥2.40b CN¥6.37b CN¥6.80b CN¥7.11b CN¥7.38b CN¥7.60b CN¥7.79b CN¥7.97b CN¥8.13b CN¥8.28b
Growth rate estimate Source Analyst x1 Analyst x1 Analyst x1 Is at 4.65% Is at 3.7% East @ 3.03% Is at 2.57% Is at 2.24% Is at 2.01% Is 1.85%
Present value (CN¥, million) discounted at 10% -CN¥2.2k CN¥5.2k CN¥5.1k CN¥4.8k CN¥4.5k CN¥4.2k CN¥3.9k CN¥3.7k CN¥3.4k CN¥3.1k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥36b

After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.5%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 10%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥8.3b × (1 + 1.5%) ÷ (10%– 1.5%) = CN¥96b

Present value of terminal value (PVTV)= TV / (1 + r)ten= CN¥96b÷ ( 1 + 10%)ten= CN¥36b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 72 billion Canadian yen. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$12.8, the company appears to be pretty good value with a 48% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.

SEHK: 358 Cash Flow Update June 1, 2022

The hypotheses

We emphasize that 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 entries, I recommend you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Jiangxi Copper 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 takes debt into account. In this calculation, we used 10%, which is based on a leveraged beta of 1.766. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

While valuing a business is important, it ideally won’t be the only piece of analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Can we understand why the company is trading at a discount to its intrinsic value? For Jiangxi Copper, we’ve put together three more things you should consider in more detail:

  1. Risks: For example, we have identified 2 warning signs for Jiangxi Copper of which you should be aware.
  2. Future earnings: How does 358’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

PS. The Simply Wall St app performs an updated cash flow valuation for each SEHK stock every day. If you want to find the calculation for other stocks, search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.