In this article we are going to estimate the intrinsic value of Euro-Tax.pl S.A. (WSE:ETX) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
|Levered FCF (PLN, Millions)||zł1.58m||zł1.25m||zł1.07m||zł975.3k||zł920.9k||zł891.8k||zł878.7k||zł876.2k||zł881.1k||zł891.1k|
|Growth Rate Estimate Source||Est @ -31.13%||Est @ -21.04%||Est @ -13.98%||Est @ -9.04%||Est @ -5.58%||Est @ -3.16%||Est @ -1.47%||Est @ -0.28%||Est @ 0.55%||Est @ 1.13%|
|Present Value (PLN, Millions) Discounted @ 7.2%||zł1.5||zł1.1||zł0.9||zł0.7||zł0.7||zł0.6||zł0.5||zł0.5||zł0.5||zł0.4|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł7.0m
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 a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.5%) 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 7.2%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = zł891k× (1 + 2.5%) ÷ (7.2%– 2.5%) = zł20m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= zł20m÷ ( 1 + 7.2%)10= zł9.8m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł17m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of zł2.8, the company appears about fair value at a 17% discount to where the stock price trades currently. 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.
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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Euro-Tax.pl 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 7.2%, which is based on a levered beta of 0.919. 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.
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. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Euro-Tax.pl, we've compiled three essential aspects you should further research:
- Risks: Case in point, we've spotted 4 warning signs for Euro-Tax.pl you should be aware of, and 2 of them are a bit unpleasant.
- 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!
- Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the WSE every day. If you want to find the calculation for other stocks just search here.
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