Is Eurocell plc (LON:ECEL) Trading At A 32% Discount?

editorial-team@simplywallst.com (Simply Wall St)

Sun, Aug 11, 2024, 11:14 PM 6 min read

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Eurocell plc (LON:ECEL) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

See our latest analysis for Eurocell

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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (£, Millions)	UK£14.9m	UK£22.4m	UK£19.1m	UK£17.3m	UK£16.2m	UK£15.6m	UK£15.3m	UK£15.2m	UK£15.2m	UK£15.3m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ -14.59%	Est @ -9.63%	Est @ -6.16%	Est @ -3.74%	Est @ -2.04%	Est @ -0.85%	Est @ -0.01%	Est @ 0.57%
Present Value (£, Millions) Discounted @ 8.3%	UK£13.7	UK£19.1	UK£15.1	UK£12.6	UK£10.9	UK£9.7	UK£8.8	UK£8.0	UK£7.4	UK£6.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£112m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 5-year average of the 10-year government bond yield (1.9%) 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 8.3%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = UK£15m× (1 + 1.9%) ÷ (8.3%– 1.9%) = UK£244m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£244m÷ ( 1 + 8.3%)¹⁰= UK£110m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is UK£222m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£1.5, the company appears quite good value at a 32% discount to where the stock price trades currently. 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 — LSE:ECEL Discounted Cash Flow August 12th 2024

Important 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 Eurocell 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 8.3%, which is based on a levered beta of 1.313. 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 Eurocell

Strength

Currently debt free.

Dividends are covered by earnings and cash flows.

Weakness

Earnings declined over the past year.

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

Opportunity

Annual earnings are forecast to grow faster than the British market.

Good value based on P/E ratio and estimated fair value.

Threat

No apparent threats visible for ECEL.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 discount to intrinsic value? For Eurocell, there are three relevant items you should explore:

Risks: For example, we've discovered 2 warning signs for Eurocell that you should be aware of before investing here.
Future Earnings: How does ECEL'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 British 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.