Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Danieli & C Officine Meccaniche SpA (BIT:DAN) as an investment opportunity by taking the expected future cash flows and discounting them to today’s value. This is done using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not November 2018 then I highly recommend you check out the latest calculation for Danieli & C. Officine Meccaniche by following the link below.
Is DAN fairly valued?
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. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF (€, Millions)||€142.00||€50.18||€168.80||€167.59||€166.39|
|Source||Analyst x2||Analyst x4||Analyst x2||Est @ -0.72%||Est @ -0.72%|
|Present Value Discounted @ 11.48%||€127.37||€40.37||€121.82||€108.49||€96.62|
Present Value of 5-year Cash Flow (PVCF)= €495m
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (1.8%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 11.5%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €166m × (1 + 1.8%) ÷ (11.5% – 1.8%) = €1.7b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €1.7b ÷ ( 1 + 11.5%)5 = €1.0b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is €1.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of €20.28. Relative to the current share price of €17.02, the stock is about right, perhaps slightly undervalued at a 16% discount to what it is available for right now.
Now 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Danieli & C. Officine Meccaniche as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11.5%, which is based on a levered beta of 1.181. This is derived from the Bottom-Up Beta method based on 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. For DAN, I’ve compiled three pertinent aspects you should further examine:
- Financial Health: Does DAN have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does DAN’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of DAN? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the BIT every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.