Is there an opportunity with Shandong Gold Mining Co., Ltd. (SHSE:600547) by reducing its value by 34%?

Key insights

• Using two-stage free cash flow to equity, the fair value of Shandong Gold Mining is CNY 35.41
• The current share price of CNY23.25 indicates that Shandong Gold Mining is likely undervalued by 34%.
• The analyst price target for 600547 is CNY 31.87 This is 10% lower than our fair value estimate

How far is Shandong Gold Mining Co., Ltd. (chs:600547) of its intrinsic value? Using the most recent financial data, we’ll look at whether a stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. Our analysis will use the discounted cash flow (DCF) model. Before you think you won’t be able to understand it, just read on! It’s actually a lot less complicated than you might imagine.

Companies can be valued in many ways, so we point out that DCF is not ideal for every situation. Anyone interested in learning more about intrinsic value should read this book Simply the Wall Street analysis model.

View our latest analysis for gold mining in Shandong

Number crunching

We use what is known as a two-stage model, which simply means that we have two different periods of growth rates for the company’s cash flows. In general, the first stage is a higher growth stage, and the second stage is a lower growth stage. First, we need to get estimates of the next 10 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 that 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 in later years.

In general, 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) forecast

(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 70 billion Chinese yuan

We now need to calculate the terminal value, which represents all 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 final cash flows to present value at a cost of equity of 9.9%.

Final value (TV)=FCF₂₀₃₄ × (1 + g) ÷ (y – g) = CN¥16b× (1 + 2.8%) ÷ (9.9% – 2.8%) = CN¥229b

Terminal Present Value (PVTV)= tv / (1 + r)¹⁰= 229 Chinese yuan ÷ (1 + 9.9%)¹⁰= 89 billion Chinese yuan

Total value, or equity value, is the sum of the present value of future cash flows, which in this case is RMB158 billion. In the final step, we divide the stock value by the number of shares outstanding. At the current share price of CNY23.3, the company looks like a very good value at a 34% discount to where the share price is currently trading. The assumptions in any calculation have a significant impact on the valuation, so it’s best to view this as a rough estimate, not accurate to the last cent.

Important assumptions

Now the most important input to discounted cash flow is the discount rate and, of course, the actual cash flows. If you disagree with this result, do the math yourself and play with the assumptions. DCF also does not take into account the potential cyclicality of the industry, or the future capital requirements of the company, so it does not give a complete picture of the company’s likely performance. Given that we view Shandong Gold Mining as a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which represents debt. In this calculation, we used 9.9%, which is based on a leverage beta of 1.435. Beta is a measure of a stock’s volatility, compared to the market as a whole. We obtain the beta from the industry average beta for globally comparable firms, with an imposed bound of 0.8–2.0, which is a reasonable range for stable businesses.

SWOT analysis of shandong gold mining

Looking forward:

Although important, the discounted cash flow calculation will not be the only part of the analysis you audit for a company. The DCF model is not a perfect tool for valuing stocks. Rather, it should be viewed as a guide to “What assumptions would have to be true for this stock to be under/overvalued?” For example, if the final value growth rate is adjusted slightly, it can change the overall result dramatically. What is the reason for the stock price remaining below the intrinsic value? For Shandong Gold Mining Company, there are three basic elements you should consider:

1. Risks: For example, we have specified 2 warning signs for gold mining in shandong (1 important) You should be aware.
2. Future profits: How does 600547’s growth rate compare to its peers and the broader market? Dive deeper into the analyst consensus number for the coming years by interacting with our site Free chart of analyst growth forecasts.
3. Other solid works: Low debt, high returns on equity, and good past performance are essential for a strong business. Why don’t you explore? Our interactive list of stocks with strong business fundamentals To see if there are other companies you may not have thought of!

Note: Simply Wall St updates its DCF calculation for each Chinese stock daily, so if you want to find the intrinsic value of just any other stock Search here.

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This article written by Simply Wall St is general in nature. We provide comments based on historical data and analyst forecasts only using 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 into account your objectives or financial situation. We aim to offer you focused, long-term analysis driven by fundamental data. Note that our analysis may not take into account the company’s most recent price-sensitive announcements or qualitative materials. Simply put, Wall St has no position in any of the stocks mentioned.