Calculating The Intrinsic Value Of Hrvatski Telekom d.d. (ZGSE:HT)

Today we will run through one way of estimating the intrinsic value of Hrvatski Telekom d.d. (ZGSE:HT) by taking the expected future cash flows and discounting them to their present value. This is done using 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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Hrvatski Telekom d.d

The method

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. To begin with, we have to get estimates of the next ten years of cash flows. 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.

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

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
Levered FCF (HRK, Millions) Kn1.06b Kn1.04b Kn1.02b Kn1.02b Kn1.01b Kn1.01b Kn1.02b Kn1.02b Kn1.02b Kn1.03b
Growth Rate Estimate Source Est @ -3.22% Est @ -2.05% Est @ -1.24% Est @ -0.67% Est @ -0.27% Est @ 0.01% Est @ 0.2% Est @ 0.34% Est @ 0.44% Est @ 0.5%
Present Value (HRK, Millions) Discounted @ 8.1% Kn980 Kn888 Kn812 Kn746 Kn689 Kn637 Kn591 Kn549 Kn510 Kn474

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = Kn6.9b

After calculating the present value of future cash flows in the intial 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 10-year government bond rate (0.7%) 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 8.1%.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = Kn1.0b× (1 + 0.7%) ÷ 8.1%– 0.7%) = Kn14b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= Kn14b÷ ( 1 + 8.1%)10= Kn6.5b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is Kn13b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of Kn174, the company appears around fair value at the time of writing. 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.

ZGSE:HT Intrinsic value, March 4th 2020
ZGSE:HT Intrinsic value, March 4th 2020

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 Hrvatski Telekom d.d 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 8.1%, which is based on a levered beta of 0.800. 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.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to “what assumptions need to be true for this stock to be under/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 Hrvatski Telekom d.d, We’ve put together three additional factors you should look at:

  1. Risks: As an example, we’ve found 1 warning sign for Hrvatski Telekom d.d that you need to consider before investing here.
  2. Future Earnings: How does HT’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 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ZGSE every day. If you want to find the calculation for other stocks just search here.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

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