A Look At The Intrinsic Value Of Sogefi S.p.A. (BIT:SO)

Today we will run through one way of estimating the intrinsic value of Sogefi S.p.A. (BIT:SO) by estimating the company's 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!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Sogefi

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (€, Millions)	€12.4m	€22.7m	€29.3m	€32.4m	€34.7m	€36.6m	€38.2m	€39.6m	€40.9m	€42.0m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x1	Analyst x1	Est @ 7.04%	Est @ 5.51%	Est @ 4.45%	Est @ 3.7%	Est @ 3.17%	Est @ 2.81%
Present Value (€, Millions) Discounted @ 22%	€10.2	€15.2	€16.1	€14.6	€12.8	€11.1	€9.5	€8.1	€6.8	€5.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €110m

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 (2.0%) 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 22%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = €42m× (1 + 2.0%) ÷ (22%– 2.0%) = €213m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €213m÷ ( 1 + 22%)¹⁰= €29m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is €139m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €1.3, 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.

Important 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 Sogefi 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 22%, which is based on a levered beta of 2.000. 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. 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. For Sogefi, we've compiled three further items you should consider:

1. Risks: As an example, we've found 2 warning signs for Sogefi (1 is significant!) that you need to consider before investing here.
2. Future Earnings: How does SO'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. Simply Wall St updates its DCF calculation for every Italian 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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