H&R GmbH & Co. KGaA (ETR:2HRA) Shares Could Be 40% Below Their Intrinsic Value Estimate
Does the April share price for H&R GmbH & Co. KGaA (ETR:2HRA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for H&R GmbH KGaA
The calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF (€, Millions) | €9.35m | €36.0m | €34.0m | €32.8m | €31.9m | €31.4m | €31.0m | €30.7m | €30.6m | €30.4m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x1 | Est @ -3.66% | Est @ -2.54% | Est @ -1.76% | Est @ -1.21% | Est @ -0.83% | Est @ -0.56% | Est @ -0.37% |
Present Value (€, Millions) Discounted @ 6.6% | €8.8 | €31.7 | €28.0 | €25.3 | €23.2 | €21.3 | €19.8 | €18.4 | €17.1 | €16.0 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €209m
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 6.6%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = €30m× (1 + 0.07%) ÷ (6.6%– 0.07%) = €464m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €464m÷ ( 1 + 6.6%)10= €244m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €453m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €7.3, the company appears quite good value at a 40% 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.
The assumptions
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 H&R GmbH KGaA 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 6.6%, which is based on a levered beta of 1.255. 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.
Next Steps:
Although the valuation of a company is important, it 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. 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 H&R GmbH KGaA, there are three fundamental aspects you should further examine:
- Risks: Case in point, we've spotted 1 warning sign for H&R GmbH KGaA you should be aware of.
- Future Earnings: How does 2HRA'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.
- 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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About XTRA:2HRA
H&R GmbH KGaA
Engages in the manufacture and sale of chemical-pharmaceutical raw materials and injection molded precision plastic parts.
Undervalued with reasonable growth potential.