Calculating The Fair Value Of Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt. (BUSE:RICHTER)

How far off is Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt. (BUSE:RICHTER) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

Check out our latest analysis for Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt

Is Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt fairly valued?

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 begin with, we have to get estimates of 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (HUF, Millions)	Ft64.1b	Ft93.3b	Ft104.5b	Ft113.8b	Ft106.2b	Ft101.9b	Ft99.4b	Ft98.1b	Ft97.6b	Ft97.7b
Growth Rate Estimate Source	Analyst x6	Analyst x6	Analyst x5	Analyst x5	Analyst x4	Est @ -4.06%	Est @ -2.43%	Est @ -1.29%	Est @ -0.49%	Est @ 0.07%
Present Value (HUF, Millions) Discounted @ 8.1%	Ft59.3k	Ft79.8k	Ft82.6k	Ft83.2k	Ft71.8k	Ft63.7k	Ft57.4k	Ft52.4k	Ft48.2k	Ft44.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = Ft643b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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) = Ft98b× (1 + 1.4%) ÷ (8.1%– 1.4%) = Ft1.5t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= Ft1.5t÷ ( 1 + 8.1%)¹⁰= Ft669b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is Ft1.3t. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of Ft7.6k, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important 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 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.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt, we've put together three essential elements you should consider:

1. Risks: We feel that you should assess the 1 warning sign for Richter Gedeon Vegyészeti Gyár Nyilvánosan Muködo Rt we've flagged before making an investment in the company.
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 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 Hungarian 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. 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.
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