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 start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF (€, Millions)||€214.38||€348.24||€374.93||€363.50||€471.50|
|Source||Analyst x4||Analyst x3||Analyst x3||Analyst x2||Analyst x2|
|Present Value Discounted @ 10.02%||€194.86||€287.72||€281.57||€248.13||€292.55|
Present Value of 5-year Cash Flow (PVCF)= €1.30b
The second stage is also known as Terminal Value, this is the business’s cash flow after 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 10%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €471.50m × (1 + 1.8%) ÷ (10% – 1.8%) = €5.83b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €5.83b ÷ ( 1 + 10%)5 = €3.62b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €4.92b. 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 €1.58. Compared to the current share price of €1.51, the stock is about right, perhaps slightly undervalued at a 4.63% discount to what it is available for right now.
I’d like to 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at A2A 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 10%, which is based on a levered beta of 1.002. 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.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For A2A, I’ve compiled three essential aspects you should further research:
- Financial Health: Does A2A 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 A2A’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 A2A? 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 for every stock on the BIT every 6 hours. If you want to find the calculation for other stocks just search here.