Are Investors Undervaluing Stemmer Imaging AG (ETR:S9I) By 43%?

Today we will run through one way of estimating the intrinsic value of Stemmer Imaging AG (ETR:S9I) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Stemmer Imaging

Crunching the numbers

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.

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

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (€, Millions)	€4.70m	€8.90m	€10.1m	€11.1m	€11.9m	€12.5m	€12.9m	€13.2m	€13.4m	€13.6m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 13.93%	Est @ 9.77%	Est @ 6.86%	Est @ 4.82%	Est @ 3.4%	Est @ 2.4%	Est @ 1.7%	Est @ 1.21%
Present Value (€, Millions) Discounted @ 6.3%	€4.4	€7.9	€8.4	€8.7	€8.8	€8.6	€8.4	€8.1	€7.8	€7.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €78m

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 6.3%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = €14m× (1 + 0.07%) ÷ (6.3%– 0.07%) = €219m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €219m÷ ( 1 + 6.3%)¹⁰= €119m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €197m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €17.4, the company appears quite good value at a 43% 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.

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 Stemmer Imaging 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 6.3%, which is based on a levered beta of 1.189. 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Stemmer Imaging, we've compiled three important items you should further examine:

1. Risks: Take risks, for example - Stemmer Imaging has 2 warning signs we think you should be aware of.
2. Future Earnings: How does S9I'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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