Calculating The Intrinsic Value Of Tronic's Microsystems SA (EPA:ALTRO)

Key Insights

• Tronic's Microsystems' estimated fair value is €4.10 based on 2 Stage Free Cash Flow to Equity
• Tronic's Microsystems' €3.38 share price indicates it is trading at similar levels as its fair value estimate
• Industry average discount to fair value of 9.7% suggests Tronic's Microsystems' peers are currently trading at a lower discount

Today we will run through one way of estimating the intrinsic value of Tronic's Microsystems SA (EPA:ALTRO) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Tronic's Microsystems

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (€, Millions)	€3.06m	€3.00m	€2.97m	€2.97m	€2.97m	€2.99m	€3.02m	€3.05m	€3.08m	€3.12m
Growth Rate Estimate Source	Est @ -3.44%	Est @ -1.99%	Est @ -0.97%	Est @ -0.25%	Est @ 0.24%	Est @ 0.59%	Est @ 0.84%	Est @ 1.01%	Est @ 1.13%	Est @ 1.21%
Present Value (€, Millions) Discounted @ 9.0%	€2.8	€2.5	€2.3	€2.1	€1.9	€1.8	€1.7	€1.5	€1.4	€1.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €19m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.4%) 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 9.0%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = €3.1m× (1 + 1.4%) ÷ (9.0%– 1.4%) = €42m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €42m÷ ( 1 + 9.0%)¹⁰= €18m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €37m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of €3.4, the company appears about fair value at a 18% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The 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. 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 Tronic's Microsystems 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 9.0%, which is based on a levered beta of 1.603. 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 Tronic's Microsystems

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. For Tronic's Microsystems, we've put together three relevant factors you should consider:

1. Risks: Be aware that Tronic's Microsystems is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ENXTPA every day. If you want to find the calculation for other stocks 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.