An Intrinsic Calculation For Expert System SpA (BIT:EXSY) Shows It’s 46.4% Undervalued

How far off is Expert System SpA (BIT:EXSY) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today’s value. I will be using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in October 2018 so be sure check out the updated calculation by following the link below.

See our latest analysis for Expert System

What’s the value?

I’m 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 perpetual stable growth rate. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow estimate

2019 2020 2021 2022 2023
Levered FCF (€, Millions) €2.37 €2.92 €6.41 €8.67 €10.06
Source Analyst x1 Analyst x2 Analyst x1 Analyst x1 Est @ 16%, capped from 24.47%
Present Value Discounted @ 11.02% €2.13 €2.37 €4.68 €5.71 €5.97

Present Value of 5-year Cash Flow (PVCF)= €21m

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (1.8%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 11%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €10m × (1 + 1.8%) ÷ (11% – 1.8%) = €111m

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €111m ÷ ( 1 + 11%)5 = €66m

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is €87m. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of €2.43. Relative to the current share price of €1.31, the stock is quite good value at a 46% discount to what it is available for right now.

BIT:EXSY Intrinsic Value Export October 22nd 18
BIT:EXSY Intrinsic Value Export October 22nd 18

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Expert System as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11%, which is based on a levered beta of 1.124. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For EXSY, there are three important aspects you should further research:

  1. Financial Health: Does EXSY 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.
  2. Future Earnings: How does EXSY’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of EXSY? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every IT stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.