Estimation of the intrinsic value of Lotus Bakeries NV (EBR:LOTB)
Today we are going to do a simple overview of a valuation method used to estimate the attractiveness of Lotus Bakeries NV (EBR:LOTB) as an investment opportunity by taking future cash flows of the company and discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for Lotus Bakeries
We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less 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
|Leveraged FCF (€, Millions)||€7.38m||€80.4 million||€113.3 million||€137.9 million||€159.2 million||€176.9 million||€191.3 million||€202.8 million||€212.0 million||€219.4 million|
|Growth rate estimate Source||Analyst x2||Analyst x2||Analyst x2||Is at 21.64%||Is at 15.47%||Is at 11.15%||Is at 8.12%||Is at 6.01%||Is at 4.53%||Is at 3.49%|
|Present value (€, millions) discounted at 4.9%||€7.0||73.0 €||€98.1||114 €||125 €||132 €||136 €||138 €||137 €||135 €|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = €1.1 billion
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.1%. We discount the terminal cash flows to their present value at a cost of equity of 4.9%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = €219m × (1 + 1.1%) ÷ (4.9%– 1.1%) = €5.7bn
Present value of terminal value (PVTV)= TV / (1 + r)ten= €5.7 billion÷ ( 1 + 4.9%)ten= €3.5 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 4.6 billion euros. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of €4.8k, the company appears to be approximately fair value at a 15% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Lotus Bakeries 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 takes debt into account. In this calculation, we used 4.9%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of 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, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For Lotus Bakeries, we’ve put together three relevant items you should explore:
- Financial health: Does LOTB have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
- Future earnings: How does LOTB’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs an updated cash flow valuation for every stock on the ENXTBR every day. If you want to find the calculation for other stocks, search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.