In this article we are going to estimate the intrinsic value of Papoutsanis S.A. (ATH:PAP) by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company’s last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) forecast
|Levered FCF (€, Millions)||€2.91m||€4.27m||€5.74m||€7.22m||€8.64m||€9.98m||€11.2m||€12.4m||€13.5m||€14.6m|
|Growth Rate Estimate Source||Est @ 64.26%||Est @ 46.69%||Est @ 34.38%||Est @ 25.77%||Est @ 19.75%||Est @ 15.53%||Est @ 12.57%||Est @ 10.5%||Est @ 9.06%||Est @ 8.04%|
|Present Value (€, Millions) Discounted @ 19%||€2.4||€3.0||€3.4||€3.6||€3.6||€3.5||€3.3||€3.1||€2.8||€2.5|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €31m
After calculating the present value of future cash flows in the intial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 5.7%. We discount the terminal cash flows to today’s value at a cost of equity of 19%.
Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = €15m× (1 + 5.7%) ÷ 19%– 5.7%) = €115m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €115m÷ ( 1 + 19%)10= €20m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €51m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €1.8, the company appears about fair value at a 10% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope – move a few degrees and end up in a different galaxy. Do keep this in mind.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company’s future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Papoutsanis 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 accounts for debt. In this calculation we’ve used 19%, which is based on a levered beta of 0.946. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to “what assumptions need to be true for this stock to be under/overvalued?” If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Papoutsanis, There are three additional aspects you should further research:
- Risks: You should be aware of the 3 warning signs for Papoutsanis we’ve uncovered before considering an investment in the company.
- Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!
- Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!
PS. Simply Wall St updates its DCF calculation for every GR stock every day, so if you want to find the intrinsic value of any other stock just search here.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.