Stock Analysis

An Intrinsic Calculation For NOS, S.G.P.S., S.A. (ELI:NOS) Suggests It's 45% Undervalued

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ENXTLS:NOS
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of NOS, S.G.P.S., S.A. (ELI:NOS) as an investment opportunity 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. It may sound complicated, but actually it is quite simple!

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.

Check out our latest analysis for NOS S.G.P.S

Crunching The Numbers

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (€, Millions) €108.9m €155.7m €185.0m €177.0m €172.5m €170.0m €168.8m €168.5m €168.8m €169.6m
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x3 Analyst x1 Est @ -2.53% Est @ -1.46% Est @ -0.71% Est @ -0.18% Est @ 0.19% Est @ 0.45%
Present Value (€, Millions) Discounted @ 5.9% €103 €139 €156 €140 €129 €120 €113 €106 €100 €95.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €1.2b

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 1.1%. We discount the terminal cash flows to today's value at a cost of equity of 5.9%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = €170m× (1 + 1.1%) ÷ (5.9%– 1.1%) = €3.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €3.5b÷ ( 1 + 5.9%)10= €2.0b

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 €3.2b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of €3.4, the company appears quite undervalued at a 45% 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.

dcf
ENXTLS:NOS Discounted Cash Flow September 29th 2022

Important 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. 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 NOS S.G.P.S 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 5.9%, which is based on a levered beta of 0.800. 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.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. What is the reason for the share price sitting below the intrinsic value? For NOS S.G.P.S, we've compiled three fundamental items you should further examine:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with NOS S.G.P.S (at least 1 which is concerning) , and understanding them should be part of your investment process.
  2. Future Earnings: How does NOS'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 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. Simply Wall St updates its DCF calculation for every Portuguese stock every day, so if you want to find the intrinsic value of any other stock just search here.

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