Key Insights

Using the 2 Stage Free Cash Flow to Equity, China Gold International Resources fair value estimate is CA$6.25 China Gold International Resources' CA$6.87 share price indicates it is trading at similar levels as its fair value estimate The US$9.50 analyst price target for CGG is 52% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of China Gold International Resources Corp. Ltd. (TSE:CGG) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for China Gold International Resources

The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF ($, Millions)  US$147.6m US$126.9m US$115.3m US$108.7m US$105.1m US$103.3m US$102.8m US$103.2m US$104.2m US$105.5m Growth Rate Estimate Source Est @ -21.03% Est @ -14.04% Est @ -9.15% Est @ -5.72% Est @ -3.32% Est @ -1.65% Est @ -0.47% Est @ 0.35% Est @ 0.93% Est @ 1.33% Present Value ($, Millions) Discounted @ 7.6%  US$137 US$110 US$92.5 US$81.0 US$72.8 US$66.5 US$61.5 US$57.3 US$53.8 US$50.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$783m

Story Continues

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.6%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$106m× (1 + 2.3%) ÷ (7.6%– 2.3%) = US$2.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.0b÷ ( 1 + 7.6%)10= US$967m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$1.7b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CA$6.9, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.TSX:CGG Discounted Cash Flow December 8th 2024

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 China Gold International Resources 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 7.6%, which is based on a levered beta of 1.299. 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.

SWOT Analysis for China Gold International Resources

Strength

Debt is well covered by cash flow.

Weakness

Interest payments on debt are not well covered.

Expensive based on P/S ratio and estimated fair value.

Opportunity

Expected to breakeven next year.

Has sufficient cash runway for more than 3 years based on current free cash flows.

Threat

No apparent threats visible for CGG.

Next Steps:

Whilst important, the DCF calculation 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. For China Gold International Resources, we've put together three important elements you should assess:

Financial Health: Does CGG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk. Future Earnings: How does CGG'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. 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. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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