Construcciones y Auxiliar de Ferrocarriles, S.A.'s (BME:CAF) Intrinsic Value Is Potentially 99% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Construcciones y Auxiliar de Ferrocarriles fair value estimate is €63.59
• Construcciones y Auxiliar de Ferrocarriles is estimated to be 50% undervalued based on current share price of €31.95
• The €40.33 analyst price target for CAF is 37% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Construcciones y Auxiliar de Ferrocarriles, S.A. (BME:CAF) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. 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 Construcciones y Auxiliar de Ferrocarriles

The Method

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (€, Millions)	€118.1m	€113.4m	€233.0m	€271.0m	€302.9m	€328.8m	€349.6m	€366.3m	€379.8m	€390.9m
Growth Rate Estimate Source	Analyst x4	Analyst x5	Analyst x1	Est @ 16.31%	Est @ 11.76%	Est @ 8.57%	Est @ 6.34%	Est @ 4.77%	Est @ 3.68%	Est @ 2.92%
Present Value (€, Millions) Discounted @ 14%	€104	€87.6	€158	€162	€159	€151	€142	€130	€119	€107

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €1.3b

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 1.1%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = €391m× (1 + 1.1%) ÷ (14%– 1.1%) = €3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €3.1b÷ ( 1 + 14%)¹⁰= €858m

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 €2.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of €32.0, the company appears quite undervalued at a 50% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Construcciones y Auxiliar de Ferrocarriles 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 14%, which is based on a levered beta of 1.455. 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 Construcciones y Auxiliar de Ferrocarriles

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. 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 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 Construcciones y Auxiliar de Ferrocarriles, there are three additional factors you should further research:

1. Risks: We feel that you should assess the 3 warning signs for Construcciones y Auxiliar de Ferrocarriles (1 makes us a bit uncomfortable!) we've flagged before making an investment in the company.
2. Future Earnings: How does CAF'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 Spanish 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. 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.