Is There An Opportunity With Med Life S.A.'s (BVB:M) 49% Undervaluation?

In this article we are going to estimate the intrinsic value of Med Life S.A. (BVB:M) by taking the expected future cash flows and discounting them to today's 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 generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Med Life

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. 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

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (RON, Millions)	RON142.3m	RON188.7m	RON234.2m	RON295.3m	RON325.8m	RON347.5m	RON364.8m	RON378.6m	RON389.9m	RON399.3m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Analyst x1	Analyst x1	Est @ 6.65%	Est @ 4.98%	Est @ 3.8%	Est @ 2.98%	Est @ 2.41%
Present Value (RON, Millions) Discounted @ 7.2%	RON133	RON164	RON190	RON224	RON230	RON229	RON224	RON217	RON208	RON199

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RON2.0b

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 1.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = RON399m× (1 + 1.1%) ÷ (7.2%– 1.1%) = RON6.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RON6.6b÷ ( 1 + 7.2%)¹⁰= RON3.3b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RON5.3b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of RON20.4, the company appears quite undervalued at a 49% 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.

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. 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 Med Life 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 7.2%, which is based on a levered beta of 0.956. 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:

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. 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. Why is the intrinsic value higher than the current share price? For Med Life, we've put together three further aspects you should explore:

1. Risks: Take risks, for example - Med Life has 1 warning sign we think you should be aware of.
2. Future Earnings: How does M'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 Romanian 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.