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In this article we are going to estimate the intrinsic value of Tenaris S.A. (BIT:TEN) by estimating the company's future cash flows and discounting them to their present value. This is done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
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.
What's the estimated valuation?
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. 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 are 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
|Levered FCF ($, Millions)||$1.08k||$1.07k||$1.22k||$1.56k||$1.56k||$1.57k||$1.59k||$1.62k||$1.65k||$1.69k|
|Growth Rate Estimate Source||Analyst x11||Analyst x13||Analyst x7||Analyst x3||Analyst x1||Est @ 0.65%||Est @ 1.34%||Est @ 1.81%||Est @ 2.15%||Est @ 2.39%|
|Present Value ($, Millions) Discounted @ 9.27%||$985.33||$896.83||$937.48||$1.10k||$1.00k||$921.49||$854.61||$796.34||$744.48||$697.61|
Present Value of 10-year Cash Flow (PVCF)= $8.93b
"Est" = FCF growth rate estimated by Simply Wall St
After calculating the present value of future cash flows in the intial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 10-year government bond rate (2.9%) 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 9.3%.
Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = US$1.7b × (1 + 2.9%) ÷ (9.3% – 2.9%) = US$28b
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = $US$28b ÷ ( 1 + 9.3%)10 = $11.34b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is $20.27b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value estimate in the company’s reported currency of $17.17. However, TEN’s primary listing is in Luxembourg, and 1 share of TEN in USD represents 0.895 ( USD/ EUR) share of NYSE:TS, so the intrinsic value per share in EUR is €15.38. Compared to the current share price of €12.42, the company appears about fair value at a 19% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
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 Tenaris 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 9.3%, which is based on a levered beta of 1.062. 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.
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?" 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 Tenaris, There are three important factors you should further examine:
- Financial Health: Does TEN have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does TEN'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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of TEN? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
Tenaris S.A., together with its subsidiaries, produces and sells seamless and welded steel tubular products; and provides related services for the oil and gas industry, and other industrial applications.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
|Analysis Area||Score (0-6)|
Read more about these checks in the individual report sections or in our analysis model.
Flawless balance sheet with solid track record.