A Look At The Fair Value Of Lokaty Budowlane S.A. (WSE:LBD)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Lokaty Budowlane fair value estimate is zł0.36
• With zł0.41 share price, Lokaty Budowlane appears to be trading close to its estimated fair value
• Industry average of 20% suggests Lokaty Budowlane's peers are currently trading at a higher premium to fair value

Does the October share price for Lokaty Budowlane S.A. (WSE:LBD) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Lokaty Budowlane

Crunching The Numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (PLN, Millions)	zł1.51m	zł1.58m	zł1.65m	zł1.72m	zł1.80m	zł1.87m	zł1.95m	zł2.02m	zł2.10m	zł2.19m
Growth Rate Estimate Source	Est @ 5.26%	Est @ 4.85%	Est @ 4.56%	Est @ 4.35%	Est @ 4.21%	Est @ 4.11%	Est @ 4.04%	Est @ 3.99%	Est @ 3.96%	Est @ 3.94%
Present Value (PLN, Millions) Discounted @ 14%	zł1.3	zł1.2	zł1.1	zł1.0	zł1.0	zł0.9	zł0.8	zł0.7	zł0.7	zł0.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł9.4m

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 (3.9%) 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 14%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = zł2.2m× (1 + 3.9%) ÷ (14%– 3.9%) = zł23m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł23m÷ ( 1 + 14%)¹⁰= zł6.6m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł16m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of zł0.4, the company appears around fair value at the time of writing. 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.

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 Lokaty Budowlane 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 14%, which is based on a levered beta of 1.881. 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.

Next Steps:

Whilst important, the DCF calculation 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. 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 Lokaty Budowlane, there are three essential aspects you should look at:

1. Risks: For example, we've discovered 5 warning signs for Lokaty Budowlane (4 are significant!) that you should be aware of before investing here.
2. 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!
3. 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. Simply Wall St updates its DCF calculation for every Polish stock every day, so if you want to find the intrinsic value of any other stock 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.