Are Investors Undervaluing Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt. (BUSE:RICHTER) By 31%?

Today we will run through one way of estimating the intrinsic value of Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt. (BUSE:RICHTER) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. 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.

See our latest analysis for Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt

The model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (HUF, Millions)	Ft63.3b	Ft102.7b	Ft126.5b	Ft148.0b	Ft163.2b	Ft174.2b	Ft183.1b	Ft190.4b	Ft196.5b	Ft201.7b
Growth Rate Estimate Source	Analyst x2	Analyst x5	Analyst x4	Analyst x4	Analyst x4	Est @ 6.72%	Est @ 5.12%	Est @ 4%	Est @ 3.21%	Est @ 2.66%
Present Value (HUF, Millions) Discounted @ 8.1%	Ft58.5k	Ft87.8k	Ft100.0k	Ft108.2k	Ft110.3k	Ft108.9k	Ft105.8k	Ft101.7k	Ft97.1k	Ft92.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = Ft971b

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. 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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 8.1%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = Ft202b× (1 + 1.4%) ÷ (8.1%– 1.4%) = Ft3.0t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= Ft3.0t÷ ( 1 + 8.1%)¹⁰= Ft1.4t

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is Ft2.4t. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of Ft8.8k, the company appears quite undervalued at a 31% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt, there are three additional elements you should assess:

1. Financial Health: Does RICHTER 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.
2. Future Earnings: How does RICHTER'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 BUSE every day. If you want to find the calculation for other stocks just search here.

If you’re looking to trade Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.