How far off is Cargotec Corporation (HEL:CGCBV) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!
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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
|Levered FCF (€, Millions)||€222.3m||€187.4m||€243.3m||€242.0m||€249.0m||€253.7m||€257.3m||€259.9m||€262.0m||€263.6m|
|Growth Rate Estimate Source||Analyst x5||Analyst x5||Analyst x4||Analyst x1||Analyst x1||Est @ 1.9%||Est @ 1.39%||Est @ 1.04%||Est @ 0.79%||Est @ 0.62%|
|Present Value (€, Millions) Discounted @ 6.7%||€208||€164||€200||€186||€180||€171||€163||€154||€146||€137|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €1.7b
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 0.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = €264m× (1 + 0.2%) ÷ (6.7%– 0.2%) = €4.0b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €4.0b÷ ( 1 + 6.7%)10= €2.1b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €3.8b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of €43.0, the company appears a touch undervalued at a 27% 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.
Now 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 Cargotec 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 6.7%, which is based on a levered beta of 1.282. 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.
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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 Cargotec, there are three further items you should assess:
- Risks: You should be aware of the 4 warning signs for Cargotec we've uncovered before considering an investment in the company.
- Future Earnings: How does CGCBV'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 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. Simply Wall St updates its DCF calculation for every Finnish 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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