Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of 1000mercis (EPA:ALMIL) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for 1000mercis by following the link below.
View our latest analysis for 1000mercis
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What’s the value?
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF (€, Millions) | €4.45 | €5.80 | €6.41 | €7.09 | €7.83 |
Source | Analyst x2 | Analyst x1 | Est @ 10.53% | Est @ 10.53% | Est @ 10.53% |
Present Value Discounted @ 8.16% | €4.11 | €4.96 | €5.07 | €5.18 | €5.29 |
Present Value of 5-year Cash Flow (PVCF)= €25m
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 0.8%. We discount this to today’s value at a cost of equity of 8.2%.
Terminal Value (TV) = FCF_{2023} × (1 + g) ÷ (r – g) = €7.8m × (1 + 0.8%) ÷ (8.2% – 0.8%) = €107m
Present Value of Terminal Value (PVTV) = TV / (1 + r)^{5} = €107m ÷ ( 1 + 8.2%)^{5} = €72m
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is €97m. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of €36.93. Compared to the current share price of €27, the stock is about right, perhaps slightly undervalued at a 27% discount to what it is available for right now.
Important 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at 1000mercis as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.2%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For ALMIL, I’ve compiled three pertinent aspects you should further examine:
- Financial Health: Does ALMIL have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does ALMIL’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of ALMIL? 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 does a DCF calculation for every FR stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.