In this article, we will estimate the intrinsic value of Cairo Communication SpA (BIT: CAI) by projecting its future cash flows and then discounting them to present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. Anyone who wants to know a little more about intrinsic value should have read the Simply Wall St analysis model.
Check out our latest analysis for Cairo Communication
What is the estimated valuation?
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”. To begin with, we need to get cash flow estimates for 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 (€, Millions)||€ 39.0m||€ 42.0m||40.0 M €||€ 39.0m||€ 38.5m||38.3 M €||38.4 M €||€ 38.7m||€ 39.1m||€ 39.6m|
|Source of estimated growth rate||Analyst x1||Analyst x1||Analyst x1||East @ -2.61%||Is @ -1.29%||East @ -0.36%||Is @ 0.28%||East @ 0.73%||Is @ 1.05%||Est @ 1.27%|
|Present value (€, Millions) discounted @ 11%||€ 35.1||€ 34.1||€ 29.2||€ 25.6||€ 22.8||€ 20.4||€ 18.4||€ 16.7||€ 15.2||€ 13.9|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 231 M €
The second stage is also known as terminal value, this is the cash flow of the business after 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 used the 5-year average of the 10-year government bond yield (1.8%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 11%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = € 40m × (1 + 1.8%) ÷ (11% – 1.8%) = € 435m
Present value of terminal value (PVTV)= TV / (1 + r)ten= € 435m ÷ (1 + 11%)ten= 153 M €
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 € 384m. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of € 2.0, the company appears to be quite undervalued with a 31% discount from 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.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual 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 Cairo Communication 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 into account debt. In this calculation, we used 11%, which is based on a leveraged beta of 1.353. 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 :
While important, calculating DCF ideally won’t be the only piece of analysis you’ll look at for a business. The DCF model is not a perfect equity valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” 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. Why is intrinsic value greater than the current share price? For Cairo Communication, we have compiled three relevant things that you should consider:
- Risks: Consider, for example, the ever-present specter of investment risk. We have identified 4 warning signs with Cairo Communication, and understanding them should be part of your investment process.
- Future benefits: How does CAI’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 may not have considered!
PS. Simply Wall St updates its DCF calculation for every Italian stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This Simply Wall St article is general in nature. 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 does not have any position in the mentioned stocks.
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