A Look At The Intrinsic Value Of Danieli & C. Officine Meccaniche S.p.A. (BIT:DAN)

Today we will run through one way of estimating the intrinsic value of Danieli & C. Officine Meccaniche S.p.A. (BIT:DAN) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Danieli & C. Officine Meccaniche

Step by step through the calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (€, Millions)	-€86.5m	€54.9m	€138.1m	€168.8m	€196.1m	€219.3m	€238.7m	€254.9m	€268.3m	€279.8m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Est @ 22.25%	Est @ 16.13%	Est @ 11.85%	Est @ 8.85%	Est @ 6.76%	Est @ 5.29%	Est @ 4.26%
Present Value (€, Millions) Discounted @ 13%	-€76.5	€42.9	€95.5	€103	€106	€105	€101	€95.2	€88.6	€81.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €741m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = €280m× (1 + 1.9%) ÷ (13%– 1.9%) = €2.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €2.5b÷ ( 1 + 13%)¹⁰= €740m

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 €1.5b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €16.4, the company appears about fair value at a 18% discount to where the stock price trades currently. 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.

The 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 Danieli & C. Officine Meccaniche 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 13%, which is based on a levered beta of 1.329. 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. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Danieli & C. Officine Meccaniche, we've put together three further factors you should further examine:

1. Risks: You should be aware of the 2 warning signs for Danieli & C. Officine Meccaniche we've uncovered before considering an investment in the company.
2. Future Earnings: How does DAN'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 BIT every day. If you want to find the calculation for other stocks 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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