Today we’re going to review one way to estimate the intrinsic value of public limited company Mosenergo (MCX: MSNG) by projecting its future cash flows and then discounting them to present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t be put off by the lingo, the math is actually pretty straightforward.
We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
See our latest analysis for Mosenergo
Step by step in the calculation
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. In the first step, we need to estimate the cash flow of the business over the next ten years. 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.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (RUB, Millions)||₽18.3b||₽16.6b||₽12.1b||9.99||₽8.96b||8.52b||₽8.41b||₽8.52b||₽8.79b||9.17b|
|Source of estimated growth rate||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Is @ -10.22%||Is @ -4.96%||Is @ -1.27%||Is 1.3%||Est @ 3.11%||East @ 4.37%|
|Present value (RUB, millions) discounted at 12%||16.3k||₽13.2k||₽8.6k||₽6.3k||5.0k||₽4.2k||₽3.7k||₽3.4k||₽3.1k||₽2.9k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 67b
The second stage is also known as terminal value, this 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 7.3%. We discount terminal cash flows to their present value at a cost of equity of 12%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = 9.2b × (1 + 7.3%) ÷ (12% – 7.3%) = ₽197b
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₽197b ÷ (1 + 12%)ten= 62b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is ₽128b. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of 2.3, the company appears to be slightly undervalued with a 28% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own 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 Mosenergo 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 takes debt into account. In this calculation, we used 12%, which is based on a leverage beta of 0.800. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
To move on :
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of the many factors you need to evaluate for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. What is the reason why the stock price is below intrinsic value? For Mosenergo, there are three essential aspects that you should consider further:
- Risks: For example, we discovered 2 warning signs for Mosenergo (1 is a little worrying!) Which you should know before investing here.
- Future benefits: How does MSNG’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count 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 might not have considered!
PS. Simply Wall St updates its DCF calculation for every Russian stock every day, so if you want to find the intrinsic value of another stock just search here.
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 shares 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 material. Simply Wall St has no position in the mentioned stocks.
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