A Look At The Fair Value Of Pkp Cargo S.A. (WSE:PKP)

Today we will run through one way of estimating the intrinsic value of Pkp Cargo S.A. (WSE:PKP) 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Pkp Cargo

The Model

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (PLN, Millions)	-zł20.0m	zł15.9m	zł26.8m	zł39.9m	zł53.8m	zł67.4m	zł79.8m	zł90.8m	zł100.2m	zł108.3m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 68.56%	Est @ 48.78%	Est @ 34.94%	Est @ 25.25%	Est @ 18.47%	Est @ 13.72%	Est @ 10.4%	Est @ 8.07%
Present Value (PLN, Millions) Discounted @ 13%	-zł17.7	zł12.5	zł18.7	zł24.6	zł29.5	zł32.7	zł34.4	zł34.6	zł33.9	zł32.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł235m

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 (2.6%) 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 13%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = zł108m× (1 + 2.6%) ÷ (13%– 2.6%) = zł1.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł1.1b÷ ( 1 + 13%)¹⁰= zł328m

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 zł563m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of zł11.8, the company appears about fair value at a 6.2% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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 Pkp Cargo 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 13%, which is based on a levered beta of 2.000. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Pkp Cargo, there are three essential aspects you should further examine:

1. Risks: As an example, we've found 1 warning sign for Pkp Cargo that you need to consider before investing here.
2. Future Earnings: How does PKP'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.