Today we'll do a simple run through of a valuation method used to estimate the attractiveness of adesso SE (ETR:ADN1) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
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 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (€, Millions)
€42.8m
€61.0m
€49.5m
€43.1m
€39.3m
€37.0m
€35.6m
€34.7m
€34.3m
€34.0m
Growth Rate Estimate Source
Analyst x3
Analyst x3
Est @ -18.89%
Est @ -12.94%
Est @ -8.77%
Est @ -5.85%
Est @ -3.81%
Est @ -2.38%
Est @ -1.38%
Est @ -0.67%
Present Value (€, Millions) Discounted @ 7.1%
€40.0
€53.2
€40.3
€32.7
€27.9
€24.5
€22.0
€20.1
€18.5
€17.1
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = €296m
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 1.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €559m÷ ( 1 + 7.1%)10= €281m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €577m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of €84.0, the company appears about fair value at a 6.1% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
XTRA:ADN1 Discounted Cash Flow January 10th 2025
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. 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 adesso 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 7.1%, which is based on a levered beta of 1.493. 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 adesso
Strength
Earnings growth over the past year exceeded its 5-year average.
Debt is well covered by cash flow.
Weakness
Earnings growth over the past year underperformed the IT industry.
Interest payments on debt are not well covered.
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.
Current share price is below our estimate of fair value.
Threat
Dividends are not covered by earnings.
Revenue is forecast to grow slower than 20% per year.
Moving On:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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. 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. For adesso, we've compiled three fundamental items you should further examine:
Risks: For example, we've discovered 2 warning signs for adesso (1 is a bit concerning!) that you should be aware of before investing here.
Future Earnings: How does ADN1'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. 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.
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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.
