Today we are going to walk through a way to estimate the intrinsic value of Intercos SpA (BIT:ICOS) by taking the expected future cash flows and discounting them to the present value. We will use the Discounted Cash Flow (DCF) model for this purpose. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
See our latest analysis for Intercos
We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF (€, Millions)||€64.0 million||€82.0m||€92.0 million||€101.0 million||€107.6 million||€113.1 million||€117.7 million||€121.7 million||€125.2 million||€128.4 million|
|Growth rate estimate Source||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Is at 6.53%||Is at 5.1%||Is at 4.09%||Is @ 3.39%||Is @ 2.9%||Is at 2.55%|
|Present value (€, millions) discounted at 8.0%||59.3 €||70.3 €||73.0 €||74.3 €||73.2 €||71.3 €||68.7 €||65.8 €||62.7 €||59.5 €|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = €678 million
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 stage. For a number of reasons, a very conservative growth rate is used which 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 present value, using a cost of equity of 8.0%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = €128 million × (1 + 1.8%) ÷ (8.0%–1.8%) = €2.1 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= €2.1 billion÷ ( 1 + 8.0%)ten= €970 million
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 1.6 billion euros. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of €13.2, the company looks slightly undervalued at a 24% discount to the current share price. Remember though 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 flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Intercos 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 8.0%, which is based on a leveraged beta of 1.002. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. 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 the valuation. Why is intrinsic value higher than the current stock price? For Intercos, we have put together three important aspects that you should consider:
- Financial health: Does ICOS have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
- Future earnings: How does ICOS’ growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. The Simply Wall St app performs a daily updated cash flow valuation for each stock on the BIT. If you want to find the calculation for other stocks, 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 only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.