Is NEUCA S.A. (WSE:NEU) Trading At A 24% Discount?

Today we will run through one way of estimating the intrinsic value of NEUCA S.A. (WSE:NEU) by taking the expected future cash flows and discounting them to their present 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for NEUCA

The calculation

We're 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 a stable growth rate. To start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (PLN, Millions)	zł149.1m	zł167.8m	zł187.7m	zł201.7m	zł212.7m	zł222.6m	zł231.7m	zł240.2m	zł248.3m	zł256.3m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x2	Analyst x2	Est @ 5.46%	Est @ 4.64%	Est @ 4.07%	Est @ 3.67%	Est @ 3.39%	Est @ 3.2%
Present Value (PLN, Millions) Discounted @ 8.1%	zł138	zł144	zł149	zł148	zł144	zł140	zł135	zł129	zł124	zł118

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł1.4b

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 (2.7%) 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 8.1%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = zł256m× (1 + 2.7%) ÷ (8.1%– 2.7%) = zł4.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł4.9b÷ ( 1 + 8.1%)¹⁰= zł2.3b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł3.6b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of zł633, the company appears a touch undervalued at a 24% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The 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 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 NEUCA 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 8.1%, which is based on a levered beta of 0.822. 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:

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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For NEUCA, there are three additional aspects you should explore:

1. Risks: Take risks, for example - NEUCA has 1 warning sign we think you should be aware of.
2. Future Earnings: How does NEU'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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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This article by Simply Wall St is general in nature. 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.
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