An Intrinsic Calculation For Detection Technology Oyj (HEL:DETEC) Suggests It's 28% Undervalued

Key Insights

• Detection Technology Oyj's estimated fair value is €17.76 based on 2 Stage Free Cash Flow to Equity
• Current share price of €12.70 suggests Detection Technology Oyj is potentially 28% undervalued
• Analyst price target for DETEC is €18.50, which is 4.2% above our fair value estimate

In this article we are going to estimate the intrinsic value of Detection Technology Oyj (HEL:DETEC) by estimating the company's future cash flows and discounting them to their present 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 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.

See our latest analysis for Detection Technology Oyj

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. To start off with, we need to estimate the next ten years of cash flows. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (€, Millions)	€11.2m	€14.6m	€13.0m	€15.0m	€15.7m	€16.3m	€16.8m	€17.2m	€17.5m	€17.8m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x2	Analyst x2	Est @ 5.21%	Est @ 3.89%	Est @ 2.96%	Est @ 2.31%	Est @ 1.86%	Est @ 1.54%
Present Value (€, Millions) Discounted @ 6.8%	€10.5	€12.8	€10.7	€11.5	€11.3	€11.0	€10.6	€10.1	€9.7	€9.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €107m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (0.8%) 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 6.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = €18m× (1 + 0.8%) ÷ (6.8%– 0.8%) = €297m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €297m÷ ( 1 + 6.8%)¹⁰= €153m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €260m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of €12.7, the company appears a touch undervalued at a 28% 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

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 Detection Technology Oyj 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 6.8%, which is based on a levered beta of 1.078. 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 Detection Technology Oyj

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. 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. 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. What is the reason for the share price sitting below the intrinsic value? For Detection Technology Oyj, we've compiled three further factors you should further research:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Detection Technology Oyj , and understanding it should be part of your investment process.
2. Future Earnings: How does DETEC'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 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. 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.