Cancom SE (ETR:COK) Shares Could Be 24% Above Their Intrinsic Value Estimate

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Cancom fair value estimate is €23.43

• Current share price of €29.06 suggests Cancom is potentially 24% overvalued

• Our fair value estimate is 38% lower than Cancom's analyst price target of €37.78

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Cancom SE (ETR:COK) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 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.

Check out our latest analysis for Cancom

What's The Estimated Valuation?

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 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, 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (€, Millions)	€114.2m	€82.2m	€68.5m	€60.6m	€55.7m	€52.6m	€50.6m	€49.3m	€48.4m	€47.9m
Growth Rate Estimate Source	Analyst x4	Analyst x5	Analyst x3	Est @ -11.60%	Est @ -8.05%	Est @ -5.56%	Est @ -3.82%	Est @ -2.60%	Est @ -1.75%	Est @ -1.15%
Present Value (€, Millions) Discounted @ 7.0%	€107	€71.8	€56.0	€46.2	€39.7	€35.1	€31.5	€28.7	€26.4	€24.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €466m

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 0.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = €48m× (1 + 0.2%) ÷ (7.0%– 0.2%) = €711m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €711m÷ ( 1 + 7.0%)¹⁰= €362m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €828m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of €29.1, the company appears slightly overvalued at the time of writing. 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

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. 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 Cancom 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 7.0%, which is based on a levered beta of 1.136. 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.

SWOT Analysis for Cancom

Strength

• Currently debt free.

Weakness

• Earnings declined over the past year.

• Dividend is low compared to the top 25% of dividend payers in the IT market.

Opportunity

• Annual earnings are forecast to grow faster than the German market.

• Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

• Dividends are not covered by earnings.

• Revenue is forecast to grow slower than 20% per year.

Next Steps:

Whilst important, the DCF calculation 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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a premium to intrinsic value? For Cancom, there are three additional aspects you should further examine:

1. Risks: To that end, you should learn about the 3 warning signs we've spotted with Cancom (including 2 which are concerning) .

2. Future Earnings: How does COK'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 German stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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