A Look At The Intrinsic Value Of Ratio Energies - Limited Partnership (TLV:RATI)

Key Insights

• Ratio Energies - Limited Partnership's estimated fair value is ₪2.87 based on 2 Stage Free Cash Flow to Equity
• Ratio Energies - Limited Partnership's ₪2.94 share price indicates it is trading at similar levels as its fair value estimate
• Peers of Ratio Energies - Limited Partnership are currently trading on average at a 39% discount

Today we will run through one way of estimating the intrinsic value of Ratio Energies - Limited Partnership (TLV:RATI) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Ratio Energies - Limited Partnership

The Method

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. To start off with, we need to estimate 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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$92.5m	US$81.6m	US$75.4m	US$71.9m	US$70.1m	US$69.3m	US$69.2m	US$69.7m	US$70.4m	US$71.5m
Growth Rate Estimate Source	Est @ -17.84%	Est @ -11.81%	Est @ -7.58%	Est @ -4.63%	Est @ -2.56%	Est @ -1.11%	Est @ -0.10%	Est @ 0.61%	Est @ 1.11%	Est @ 1.46%
Present Value ($, Millions) Discounted @ 9.6%	US$84.4	US$67.9	US$57.3	US$49.8	US$44.3	US$40.0	US$36.4	US$33.4	US$30.9	US$28.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$473m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 9.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$71m× (1 + 2.3%) ÷ (9.6%– 2.3%) = US$997m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$997m÷ ( 1 + 9.6%)¹⁰= US$398m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$871m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of ₪2.9, 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

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 Ratio Energies - Limited Partnership 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 9.6%, which is based on a levered beta of 1.424. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and 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 Ratio Energies - Limited Partnership, we've put together three further factors you should assess:

1. Risks: You should be aware of the 2 warning signs for Ratio Energies - Limited Partnership we've uncovered before considering an investment in the company.
2. 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!
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. Simply Wall St updates its DCF calculation for every Israeli 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. 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.