In this article we are going to estimate the intrinsic value of Agora S.A. (WSE:AGO) by taking the expected future cash flows and discounting them 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.
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.
Is Agora fairly valued?
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 discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
|Levered FCF (PLN, Millions)||zł5.90m||-zł80.2m||zł51.4m||zł59.1m||zł65.8m||zł70.9m||zł75.4m||zł79.3m||zł82.9m||zł86.1m|
|Growth Rate Estimate Source||Analyst x2||Analyst x2||Analyst x2||Analyst x2||Analyst x2||Est @ 7.79%||Est @ 6.27%||Est @ 5.21%||Est @ 4.47%||Est @ 3.95%|
|Present Value (PLN, Millions) Discounted @ 15%||zł5.1||-zł61.0||zł34.1||zł34.1||zł33.1||zł31.1||zł28.8||zł26.5||zł24.1||zł21.8|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł177m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.7%. We discount the terminal cash flows to today's value at a cost of equity of 15%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = zł86m× (1 + 2.7%) ÷ (15%– 2.7%) = zł739m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= zł739m÷ ( 1 + 15%)10= zł187m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł364m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of zł7.3, the company appears about fair value at a 6.9% 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 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 Agora 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 15%, which is based on a levered beta of 1.847. 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.
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. 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. 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 Agora, we've put together three further factors you should consider:
- Risks: Every company has them, and we've spotted 2 warning signs for Agora you should know about.
- Future Earnings: How does AGO'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.
- 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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