Today we will run through one way of estimating the intrinsic value of CIE Automotive, S.A. (BME:CIE) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will be using the Discounted Cash Flow (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis 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. To begin with, we have to get estimates of 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) forecast
|Levered FCF (€, Millions)||€219.5m||€282.7m||€359.9m||€385.3m||€404.8m||€419.6m||€430.8m||€439.4m||€446.0m||€451.2m|
|Growth Rate Estimate Source||Analyst x2||Analyst x5||Analyst x3||Est @ 7.06%||Est @ 5.06%||Est @ 3.66%||Est @ 2.68%||Est @ 1.99%||Est @ 1.51%||Est @ 1.17%|
|Present Value (€, Millions) Discounted @ 14%||€193||€219||€246||€231||€214||€195||€177||€158||€142||€126|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €1.9b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 0.4%. We discount the terminal cash flows to today’s value at a cost of equity of 14%.
Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = €451m× (1 + 0.4%) ÷ 14%– 0.4%) = €3.4b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €3.4b÷ ( 1 + 14%)10= €959m
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 €2.9b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of €13.2, the company appears quite good value at a 40% 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.BME:CIE Intrinsic value April 7th 2020
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 CIE Automotive 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 14%, which is based on a levered beta of 1.770. 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, 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. 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 to differ from the intrinsic value? For CIE Automotive, We’ve put together three important aspects you should further examine:Risks: Take risks, for example – CIE Automotive has 3 warning signs we think you should be aware of. Future Earnings: How does CIE’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 BME every day. If you want to find the calculation for other stocks just search here.
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