Today we will run through one way of estimating the intrinsic value of ChemoMetec A/S (CPH:CHEMM) by taking the expected future cash flows and discounting them to today's value. I will be using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.
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 ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
Levered FCF (DKK, Millions)
DKK38.6m
DKK57.2m
DKK76.6m
DKK94.8m
DKK110.7m
DKK123.7m
DKK134.0m
DKK141.9m
DKK147.8m
DKK152.2m
Growth Rate Estimate Source
Est @ 68.99%
Est @ 48.36%
Est @ 33.91%
Est @ 23.8%
Est @ 16.73%
Est @ 11.77%
Est @ 8.3%
Est @ 5.88%
Est @ 4.18%
Est @ 2.99%
Present Value (DKK, Millions) Discounted @ 6.3%
DKK36.3
DKK50.6
DKK63.8
DKK74.3
DKK81.6
DKK85.8
DKK87.4
DKK87.0
DKK85.3
DKK82.6
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF)= DKK734.0m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 10-year government bond rate (0.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.3%.
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = DKKø2.5b ÷ ( 1 + 6.3%)10 = DKK1.36b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is DKK2.09b. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of DKK137.31. Compared to the current share price of DKK148.4, the company appears around fair value at the time of writing. 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.
CPSE:CHEMM Intrinsic value, September 15th 2019
The assumptions
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 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 ChemoMetec 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 6.3%, which is based on a levered beta of 1.021. 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.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 ChemoMetec, I've put together three additional aspects you should further research:
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of CHEMM? 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 valuation for every stock on the CPH every day. If you want to find the calculation for other stocks just search here.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
