Calculating The Fair Value Of Eurotel S.A. (WSE:ETL)

In this article we are going to estimate the intrinsic value of Eurotel S.A. (WSE:ETL) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing 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.

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.

See our latest analysis for Eurotel

What's the estimated valuation?

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.

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) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (PLN, Millions)	zł21.4m	zł19.2m	zł18.0m	zł17.4m	zł17.1m	zł17.1m	zł17.2m	zł17.4m	zł17.7m	zł18.0m
Growth Rate Estimate Source	Est @ -15.44%	Est @ -9.99%	Est @ -6.17%	Est @ -3.5%	Est @ -1.63%	Est @ -0.32%	Est @ 0.6%	Est @ 1.24%	Est @ 1.69%	Est @ 2.01%
Present Value (PLN, Millions) Discounted @ 11%	zł19.2	zł15.5	zł13.0	zł11.3	zł9.9	zł8.9	zł8.0	zł7.3	zł6.6	zł6.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł105m

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. 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 11%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = zł18m× (1 + 2.7%) ÷ (11%– 2.7%) = zł212m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł212m÷ ( 1 + 11%)¹⁰= zł71m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is zł176m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of zł38.0, the company appears about fair value at a 19% 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

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 Eurotel 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 11%, which is based on a levered beta of 1.349. 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.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Eurotel, there are three relevant items you should assess:

1. Risks: For example, we've discovered 2 warning signs for Eurotel 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. 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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