F.I.L.A. - Fabbrica Italiana Lapis ed Affini S.p.A. (BIT:FILA) Shares Could Be 25% Above Their Intrinsic Value Estimate

In this article we are going to estimate the intrinsic value of F.I.L.A. - Fabbrica Italiana Lapis ed Affini S.p.A. (BIT:FILA) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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 F.I.L.A. - Fabbrica Italiana Lapis ed Affini

The calculation

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (€, Millions)	€55.8m	€56.5m	€54.6m	€53.6m	€53.3m	€53.3m	€53.7m	€54.2m	€54.9m	€55.7m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Est @ -3.3%	Est @ -1.75%	Est @ -0.67%	Est @ 0.09%	Est @ 0.62%	Est @ 0.99%	Est @ 1.25%	Est @ 1.43%
Present Value (€, Millions) Discounted @ 15%	€48.6	€42.9	€36.2	€31.0	€26.9	€23.4	€20.6	€18.1	€16.0	€14.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €277m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 15%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = €56m× (1 + 1.9%) ÷ (15%– 1.9%) = €442m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €442m÷ ( 1 + 15%)¹⁰= €112m

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 €389m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €9.6, the company appears slightly overvalued 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 F.I.L.A. - Fabbrica Italiana Lapis ed Affini 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 15%, which is based on a levered beta of 1.516. 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. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a premium to intrinsic value? For F.I.L.A. - Fabbrica Italiana Lapis ed Affini, there are three further items you should look at:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with F.I.L.A. - Fabbrica Italiana Lapis ed Affini (at least 1 which is concerning) , and understanding these should be part of your investment process.
2. Future Earnings: How does FILA'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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