Are Investors Undervaluing Metallurgical Corporation of China Ltd. (HKG:1618) By 37%?

Key Insights

• Metallurgical Corporation of China's estimated fair value is HK$3.00 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$1.90 suggests Metallurgical Corporation of China is potentially 37% undervalued
• The CN¥2.55 analyst price target for 1618 is 15% less than our estimate of fair value

How far off is Metallurgical Corporation of China Ltd. (HKG:1618) 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. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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Is Metallurgical Corporation of China Fairly Valued?

We're using the 2-stage growth 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 a stable growth rate. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CN¥, Millions)	CN¥5.43b	CN¥9.63b	CN¥8.05b	CN¥7.20b	CN¥6.72b	CN¥6.47b	CN¥6.35b	CN¥6.33b	CN¥6.36b	CN¥6.44b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -16.40%	Est @ -10.63%	Est @ -6.60%	Est @ -3.77%	Est @ -1.79%	Est @ -0.41%	Est @ 0.56%	Est @ 1.24%
Present Value (CN¥, Millions) Discounted @ 13%	CN¥4.8k	CN¥7.5k	CN¥5.5k	CN¥4.4k	CN¥3.6k	CN¥3.1k	CN¥2.6k	CN¥2.3k	CN¥2.1k	CN¥1.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥38b

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 13%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥6.4b× (1 + 2.8%) ÷ (13%– 2.8%) = CN¥63b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥63b÷ ( 1 + 13%)¹⁰= CN¥18b

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¥56b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$1.9, the company appears quite good value at a 37% 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.

The 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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Metallurgical Corporation of China 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 13%, which is based on a levered beta of 2.000. 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.

See our latest analysis for Metallurgical Corporation of China

SWOT Analysis for Metallurgical Corporation of China

Next Steps:

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Metallurgical Corporation of China, we've put together three additional factors you should look at:

1. Risks: For example, we've discovered 2 warning signs for Metallurgical Corporation of China that you should be aware of before investing here.
2. Future Earnings: How does 1618'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 SEHK 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.