Stock Analysis

Traton SE (ETR:8TRA) Shares Could Be 49% Below Their Intrinsic Value Estimate

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XTRA:8TRA
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Traton fair value estimate is €32.49
  • Traton's €16.60 share price signals that it might be 49% undervalued
  • Our fair value estimate is 36% lower than Traton's analyst price target of €20.90

In this article we are going to estimate the intrinsic value of Traton SE (ETR:8TRA) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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.

View our latest analysis for Traton

The Method

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. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (€, Millions) €1.34b €1.48b €1.70b €1.85b €1.96b €2.05b €2.11b €2.16b €2.20b €2.22b
Growth Rate Estimate Source Analyst x4 Analyst x6 Analyst x2 Est @ 8.82% Est @ 6.22% Est @ 4.40% Est @ 3.13% Est @ 2.24% Est @ 1.62% Est @ 1.18%
Present Value (€, Millions) Discounted @ 12% €1.2k €1.2k €1.2k €1.2k €1.1k €1.0k €954 €871 €790 €713

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €10b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.2%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = €2.2b× (1 + 0.2%) ÷ (12%– 0.2%) = €19b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €19b÷ ( 1 + 12%)10= €6.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €16b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €16.6, the company appears quite undervalued at a 49% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
XTRA:8TRA Discounted Cash Flow March 16th 2023

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Traton 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 12%, which is based on a levered beta of 2.000. 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.

SWOT Analysis for Traton

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Machinery market.
Opportunity
  • Annual earnings are forecast to grow faster than the German market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Paying a dividend but company has no free cash flows.
  • Annual revenue is forecast to grow slower than the German market.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Traton, we've compiled three additional factors you should assess:

  1. Risks: As an example, we've found 3 warning signs for Traton (1 makes us a bit uncomfortable!) that you need to consider before investing here.
  2. Future Earnings: How does 8TRA's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every German stock every day, so if you want to find the intrinsic value of any other stock just search here.

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