Does the September share price for Deutsche Post AG (ETR: DPW) reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.
There are many ways businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for Deutsche Post
Step by step in the calculation
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. 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.
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
|Leverage FCF (€, Millions)||3.25 billion euros||3.78 billion euros||4.27 billion euros||4.76 billion euros||5.09 billion euros||5.33 billion euros||€ 5.52 billion||5.65 billion euros||5.74 billion euros||5.81 billion euros|
|Source of estimated growth rate||Analyst x9||Analyst x8||Analyst x2||Analyst x2||Is 6.95%||Est @ 4.87%||East @ 3.41%||East @ 2.39%||East @ 1.68%||Est @ 1.18%|
|Present value (€, Millions) discounted @ 4.7%||€ 3.1k||€ 3.5k||€ 3.7k||4.0 K €||4.0 K €||€ 4.1k||4.0 K €||3.9 k €||3.8 k €||€ 3.7k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = € 38bn
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 0.01%. We discount the terminal cash flows to their present value at a cost of equity of 4.7%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = € 5.8bn × (1 + 0.01%) ÷ (4.7% – 0.01%) = € 124bn
Present value of terminal value (PVTV)= TV / (1 + r)ten= € 124bn ÷ (1 + 4.7%)ten= € 79bn
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the Total Equity Value, which in this case is 116 billion euros. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current price of 57.4 €, the company seems quite undervalued with a discount of 39% compared to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is 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 Deutsche Post 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 4.7%, which is based on a leveraged beta of 0.990. 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.
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. It is not possible to achieve a rock-solid valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. 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. Can we understand why the company trades at a discount to its intrinsic value? For Deutsche Post, we have compiled three fundamental factors to consider:
- Risks: Concrete example, we have spotted 1 warning sign for Deutsche Post you must be aware.
- Future benefits: How does DPW’s growth rate compare to that of 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 might not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every share on the XTRA. 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 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 documents. Simply Wall St has no position in any of the stocks mentioned.
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