Are Investors Undervaluing Danieli & C. Officine Meccaniche S.p.A. (BIT:DAN) By 50%?

Key Insights

• The projected fair value for Danieli & C. Officine Meccaniche is €54.73 based on 2 Stage Free Cash Flow to Equity
• Current share price of €27.50 suggests Danieli & C. Officine Meccaniche is potentially 50% undervalued
• The €43.25 analyst price target for DAN is 21% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Danieli & C. Officine Meccaniche S.p.A. (BIT:DAN) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

We've discovered 1 warning sign about Danieli & C. Officine Meccaniche. View them for free.

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. 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (€, Millions)	€130.7m	€154.6m	€260.9m	€328.4m	€390.4m	€445.1m	€492.3m	€532.8m	€567.7m	€598.3m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Est @ 25.85%	Est @ 18.89%	Est @ 14.02%	Est @ 10.61%	Est @ 8.22%	Est @ 6.55%	Est @ 5.38%
Present Value (€, Millions) Discounted @ 12%	€117	€123	€186	€209	€222	€226	€223	€216	€205	€193

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €1.9b

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 2.7%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = €598m× (1 + 2.7%) ÷ (12%– 2.7%) = €6.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €6.6b÷ ( 1 + 12%)¹⁰= €2.1b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €4.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of €27.5, the company appears quite undervalued at a 50% 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.

Important Assumptions

Now 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 12%, which is based on a levered beta of 1.283. 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.

Check out our latest analysis for Danieli & C. Officine Meccaniche

SWOT Analysis for Danieli & C. Officine Meccaniche

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Danieli & C. Officine Meccaniche, we've compiled three fundamental elements you should look at:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Danieli & C. Officine Meccaniche .
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. 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.