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How far off is Metallurgical Corporation of China Ltd (SEHK:1618) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced using the discounted cash flows (DCF) model. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. If you are reading this after March 2018 then I highly recommend you check out the latest calculation for Metallurgical of China here.
Crunching the numbers
We are going to use a two-stage DCF model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. Generally I like to use analyst consensus estimates for free cash flow, but given that 1618 has low analyst coverage with no forecast available, I have extrapolated the most recent reported free cash flow (FCF) based on the average annual revenue growth over the past five years, capped at a reasonable level, and discounted these figures at the rate of 9.51%. This resulted in a present value of 5-year cash flow of CN¥14.93B. Want to know how I arrived at this number? Check out our detailed analysis here.
The infographic above illustrates how 1618’s earnings are expected to move in the future, which should give you some color on 1618’s outlook. Secondly, I calculate the terminal value, which is the business’s cash flow after the first stage. It’s appropriate to use the 10-year government bond rate of 2.8% as the steady growth rate, which is rightly below GDP growth, but more towards the conservative side. Discounting the terminal value back five years gives us a present value of CN¥33.97B.
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥48.90B. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of HK$2.93, which, compared to the current share price of HK$2.32, we find that Metallurgical of China is about right, perhaps slightly undervalued at a 20.80% discount to what it is available for right now.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 1618, there are three essential aspects you should further examine: