Are Investors Undervaluing MS Industrie AG (ETR:MSAG) By 47%?

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of MS Industrie AG (ETR:MSAG) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

See our latest analysis for MS Industrie

The calculation

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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (€, Millions)	€8.10m	€8.70m	€9.10m	€9.40m	€9.62m	€9.77m	€9.89m	€9.97m	€10.0m	€10.1m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 4.62%	Est @ 3.26%	Est @ 2.3%	Est @ 1.63%	Est @ 1.16%	Est @ 0.84%	Est @ 0.61%	Est @ 0.45%
Present Value (€, Millions) Discounted @ 10%	€7.3	€7.1	€6.8	€6.3	€5.9	€5.4	€4.9	€4.5	€4.1	€3.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €56m

The second stage is also known as Terminal Value, this is the business's cash flow 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 have used the 5-year average of the 10-year government bond yield (0.07%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = €10m× (1 + 0.07%) ÷ (10%– 0.07%) = €97m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €97m÷ ( 1 + 10%)¹⁰= €36m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is €92m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €1.6, the company appears quite undervalued at a 47% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 MS Industrie 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 10%, which is based on a levered beta of 1.981. 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.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For MS Industrie, we've put together three further aspects you should further research:

1. Risks: To that end, you should learn about the 4 warning signs we've spotted with MS Industrie (including 1 which makes us a bit uncomfortable) .
2. Future Earnings: How does MSAG'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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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.
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