In this article I am going to calculate the intrinsic value of Brembo SpA (BIT:BRE) by taking the expected future cash flows and discounting them to their present 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. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for Brembo by following the link below.

See our latest analysis for Brembo

Step by step through the calculation

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. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow forecast

Present Value of 5-year Cash Flow (PVCF)= €919m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.8%. We discount this to today’s value at a cost of equity of 10.8%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = €314m × (1 + 1.8%) ÷ (10.8% – 1.8%) = €3.5b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = €3.5b ÷ ( 1 + 10.8%)⁵ = €2.1b

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 €3.0b. 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 €9.36. Relative to the current share price of €11.16, the stock is fair value, maybe slightly overvalued at the time of writing.

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Brembo 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 10.8%, which is based on a levered beta of 1.097. 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.