Stock Analysis

Calculating The Intrinsic Value Of PATRIZIA SE (ETR:PAT)

Key Insights

• PATRIZIA's estimated fair value is €10.15 based on 2 Stage Free Cash Flow to Equity
• PATRIZIA's €9.76 share price indicates it is trading at similar levels as its fair value estimate
• The €13.00 analyst price target for PAT is 28% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of PATRIZIA SE (ETR:PAT) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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.

Check out our latest analysis for PATRIZIA

Step By Step Through The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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

 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (€, Millions) €49.5m €59.1m €71.6m €68.5m €66.4m €65.0m €64.1m €63.6m €63.2m €63.0m Growth Rate Estimate Source Analyst x2 Analyst x3 Analyst x3 Est @ -4.44% Est @ -3.03% Est @ -2.05% Est @ -1.36% Est @ -0.88% Est @ -0.55% Est @ -0.31% Present Value (€, Millions) Discounted @ 7.4% €46.1 €51.3 €57.8 €51.5 €46.5 €42.4 €38.9 €35.9 €33.3 €30.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €435m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 7.4%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = €63m× (1 + 0.2%) ÷ (7.4%– 0.2%) = €884m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €884m÷ ( 1 + 7.4%)10= €433m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €868m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €9.8, the company appears about fair value at a 3.8% 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 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 PATRIZIA 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 7.4%, which is based on a levered beta of 1.203. 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 PATRIZIA

Strength
• Debt is not viewed as a risk.
Weakness
• Earnings declined over the past year.
• Dividend is low compared to the top 25% of dividend payers in the Real Estate market.
Opportunity
• Annual earnings are forecast to grow faster than the German market.
• Current share price is below our estimate of fair value.
Threat
• Dividends are not covered by earnings.
• Annual revenue is forecast to grow slower than the German market.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. 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 PATRIZIA, we've put together three relevant items you should further research:

1. Risks: For instance, we've identified 2 warning signs for PATRIZIA that you should be aware of.
2. Future Earnings: How does PAT'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 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!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the XTRA every day. If you want to find the calculation for other stocks just search here.

New: Manage All Your Stock Portfolios in One Place

We've created the ultimate portfolio companion for stock investors, and it's free.

• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.