Today we are going to review a valuation method used to estimate the attractiveness of JD Logistics, Inc. (HKG: 2618) as an investment opportunity by taking expected future cash flows and taking them into account. discounting to today’s value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
Check out our latest analysis for JD Logistics
The model
We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:
10-year Free Cash Flow (FCF) estimate
| 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
| Leverage FCF (CN ¥, Million) | CN ¥ 1.92b | CN ¥ 3.60b | CN ¥ 4.42b | CN ¥ 5.14b | CN ¥ 5.75b | CN ¥ 6.26b | CN ¥ 6.67b | CN ¥ 7.01b | CN ¥ 7.29b | CN ¥ 7.53b |
| Source of estimated growth rate | Analyst x6 | Analyst x6 | East @ 22.8% | East @ 16.41% | Est @ 11.93% | Est @ 8.79% | East @ 6.6% | East @ 5.06% | Is @ 3.99% | East @ 3.24% |
| Present value (CN ¥, Million) discounted @ 6.5% | CN ¥ 1.8k | CN ¥ 3.2k | CN ¥ 3.7k | CN ¥ 4.0k | CN ¥ 4.2k | CN ¥ 4.3k | CN ¥ 4.3k | CN ¥ 4.2k | CN ¥ 4.1k | CN ¥ 4.0k |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = CN ¥ 38b
The second stage is also known as terminal value, it is the cash flow of the business after the first stage. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.5%. We discount the terminal cash flows to their present value at a cost of equity of 6.5%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN ¥ 7.5b × (1 + 1.5%) ÷ (6.5% – 1.5%) = CN ¥ 152b
Present value of terminal value (PVTV)= TV / (1 + r)ten= CN ¥ 152b ÷ (1 + 6.5%)ten= CN ¥ 81b
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is CN ¥ 119b. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of HK $ 28.0, the company appears to be around fair value at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
The above calculation is very dependent on two assumptions. One is the discount rate and the other is the cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view JD Logistics 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 takes debt into account. In this calculation, we have used 6.5%, which is based on a leveraged beta of 1.012. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our industry average beta from comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a business. DCF models are not the ultimate solution for investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For JD Logistics, there are three essential factors to take into account:
- Risks: Note that JD Logistics displays 2 warning signs in our investment analysis , you must know…
- Future benefits: How does 2618’s growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each SEHK share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.