Estimating The Fair Value Of Recordati Industria Chimica e Farmaceutica S.p.A. (BIT:REC)
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Recordati Industria Chimica e Farmaceutica fair value estimate is €47.70
- Current share price of €51.40 suggests Recordati Industria Chimica e Farmaceutica is potentially trading close to its fair value
- Analyst price target for REC is €53.49, which is 12% above our fair value estimate
Today we will run through one way of estimating the intrinsic value of Recordati Industria Chimica e Farmaceutica S.p.A. (BIT:REC) by taking the expected 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 would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
View our latest analysis for Recordati Industria Chimica e Farmaceutica
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. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, 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) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (€, Millions) | €574.6m | €626.3m | €590.0m | €588.5m | €591.7m | €598.2m | €607.1m | €617.8m | €629.9m | €643.1m |
Growth Rate Estimate Source | Analyst x4 | Analyst x4 | Analyst x1 | Est @ -0.25% | Est @ 0.54% | Est @ 1.10% | Est @ 1.49% | Est @ 1.76% | Est @ 1.95% | Est @ 2.09% |
Present Value (€, Millions) Discounted @ 7.8% | €533 | €539 | €470 | €435 | €406 | €380 | €358 | €338 | €319 | €302 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €4.1b
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 (2.4%) 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 7.8%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = €643m× (1 + 2.4%) ÷ (7.8%– 2.4%) = €12b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €12b÷ ( 1 + 7.8%)10= €5.7b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €9.8b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €51.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The 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 Recordati Industria Chimica e Farmaceutica 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 7.8%, which is based on a levered beta of 0.800. 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.
SWOT Analysis for Recordati Industria Chimica e Farmaceutica
- Debt is well covered by earnings and cashflows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Pharmaceuticals market.
- Current share price is above our estimate of fair value.
- Annual earnings are forecast to grow faster than the Italian market.
- Dividends are not covered by cash flow.
- Revenue is forecast to grow slower than 20% per year.
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. DCF models are not the be-all and end-all of investment valuation. 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 Recordati Industria Chimica e Farmaceutica, there are three relevant factors you should consider:
- Risks: We feel that you should assess the 2 warning signs for Recordati Industria Chimica e Farmaceutica we've flagged before making an investment in the company.
- Future Earnings: How does REC'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: Do you like a good all-rounder? 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.
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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.
About BIT:REC
Recordati Industria Chimica e Farmaceutica
Engages in the research, development, manufacture, and marketing of pharmaceuticals worldwide.
Reasonable growth potential average dividend payer.