Does the August share price for MARR SpA (BIT: MARR) reflect its true value? Today, we’re going to estimate the intrinsic value of the stock by projecting its future cash flows, then discounting them to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
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. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
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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. 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.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (€, Millions)||€ 37.1m||€ 68.8m||€ 70.3m||€ 71.8m||€ 73.2m||€ 74.6m||€ 76.0m||€ 77.4m||78.8 M €||€ 80.2m|
|Source of growth rate estimate||Analyst x4||Analyst x3||Is @ 2.16%||East @ 2.05%||East @ 1.97%||Est @ 1.92%||Est @ 1.88%||Is @ 1.85%||East @ 1.83%||East @ 1.82%|
|Present value (€, Millions) discounted at 7.3%||€ 34.6||€ 59.8||€ 57.0||€ 54.2||€ 51.5||€ 48.9||€ 46.5||€ 44.1||€ 41.9||€ 39.8|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 478 M €
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 7.3%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = € 80m × (1 + 1.8%) ÷ (7.3% – 1.8%) = € 1.5bn
Present value of terminal value (PVTV)= TV / (1 + r)ten= € 1.5bn ÷ (1 + 7.3%)ten= 739 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 1.2 billion euros. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current price of 22.5 €, the company appears to be slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. 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 consider MARR 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 7.3%, 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.
While a business valuation is important, ideally, it won’t be the only analysis you look at for a business. The DCF model is not a perfect equity valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. Why is intrinsic value lower than the current share price? For MARR, we’ve compiled three more factors you should explore:
- Risks: For example, we discovered 1 warning sign for MARR which you should know before investing here.
- Future benefits: How does MARR’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 high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every ILO share. If you want to find the calculation for other actions, do a 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 documents. Simply Wall St has no position in the mentioned stocks.
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