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In this article I am going to calculate the intrinsic value of PVA TePla AG (ETR:TPE) by estimating the company’s future cash flows and discounting them to their present value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! 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. Please also note that this article was written in December 2018 so be sure check out the updated calculation by following the link below.

View our latest analysis for PVA TePla

The calculation

I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow estimate

Present Value of 5-year Cash Flow (PVCF)= €66m

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 an annual growth rate equal to the 10-year government bond rate of 0.5%. We discount this to today’s value at a cost of equity of 8.8%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = €14m × (1 + 0.5%) ÷ (8.8% – 0.5%) = €175m

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = €175m ÷ ( 1 + 8.8%)⁵ = €115m

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 €181m. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of €8.31. Compared to the current share price of €11.15, the stock is quite expensive at the time of writing.

Important assumptions

I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 PVA TePla 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 8.8%, which is based on a levered beta of 0.870. 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.