Is Grupa Azoty S.A. (WSE:ATT) Trading At A 34% Discount?

Does the February share price for Grupa Azoty S.A. (WSE:ATT) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 Grupa Azoty

The method

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. To begin with, we have to get estimates of 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (PLN, Millions)	-zł645.5m	zł174.5m	zł760.5m	zł747.0m	zł726.5m	zł718.9m	zł719.0m	zł724.5m	zł733.7m	zł745.7m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Analyst x2	Analyst x2	Est @ -1.05%	Est @ 0.01%	Est @ 0.76%	Est @ 1.28%	Est @ 1.64%
Present Value (PLN, Millions) Discounted @ 12%	-zł578	zł140	zł546	zł481	zł419	zł371	zł332	zł300	zł272	zł248

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł2.5b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = zł746m× (1 + 2.5%) ÷ (12%– 2.5%) = zł8.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł8.3b÷ ( 1 + 12%)¹⁰= zł2.8b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł5.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of zł35.4, the company appears quite undervalued at a 34% 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.

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Grupa Azoty 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 12%, which is based on a levered beta of 1.800. 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:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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 Grupa Azoty, we've compiled three essential items you should consider:

1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Grupa Azoty (including 1 which is a bit unpleasant) .
2. Future Earnings: How does ATT'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: 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!

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.