Calculating The Fair Value Of Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP S.A. (WSE:KMP)

How far off is Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP S.A. (WSE:KMP) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP

The 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. 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) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (PLN, Millions)	zł6.62m	zł6.63m	zł6.69m	zł6.79m	zł6.91m	zł7.06m	zł7.22m	zł7.40m	zł7.58m	zł7.78m
Growth Rate Estimate Source	Est @ -1%	Est @ 0.12%	Est @ 0.91%	Est @ 1.46%	Est @ 1.84%	Est @ 2.11%	Est @ 2.3%	Est @ 2.43%	Est @ 2.52%	Est @ 2.59%
Present Value (PLN, Millions) Discounted @ 14%	zł5.8	zł5.1	zł4.5	zł4.0	zł3.6	zł3.2	zł2.9	zł2.6	zł2.3	zł2.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł35m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 14%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = zł7.8m× (1 + 2.7%) ÷ (14%– 2.7%) = zł70m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł70m÷ ( 1 + 14%)¹⁰= zł19m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł54m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of zł14.5, 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

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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP 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 1.757. 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 ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP, we've put together three fundamental elements you should look at:

1. Risks: Case in point, we've spotted 4 warning signs for Przedsiebiorstwo Produkcyjno - Handlowe KOMPAP you should be aware of, and 1 of them can't be ignored.
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 Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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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