Investors Are Undervaluing Progress Werk Oberkirch AG (FRA:PWO) By 40.29%

Simply Wall St.

Thu, Nov 22, 2018, 2:17 AM

I am going to run you through how I calculated the intrinsic value of Progress Werk Oberkirch AG (FRA:PWO) by taking the expected future cash flows and discounting them to today’s value. This is done using 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 November 2018 so be sure check out the updated calculation by following the link below.

See our latest analysis for Progress Werk Oberkirch

The 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 five years of cash flows. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow estimate

	2019	2020	2021	2022	2023
Levered FCF (€, Millions)	€25.54	€26.82	€28.16	€29.56	€31.03
Source	Est @ 4.99%	Est @ 4.99%	Est @ 4.99%	Est @ 4.99%	Est @ 4.99%
Present Value Discounted @ 19.46%	€21.38	€18.79	€16.52	€14.52	€12.76

Present Value of 5-year Cash Flow (PVCF)= €84m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (0.5%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 19.5%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = €31m × (1 + 0.5%) ÷ (19.5% – 0.5%) = €165m

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = €165m ÷ ( 1 + 19.5%)⁵ = €68m

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 €152m. 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 €48.57. Relative to the current share price of €29, the stock is quite undervalued at a 40% discount to what it is available for right now.

DB:PWO Intrinsic Value Export November 22nd 18

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Progress Werk Oberkirch 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 19.5%, which is based on a levered beta of 2. 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.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For PWO, I’ve put together three important aspects you should further research:

Financial Health: Does PWO have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does PWO’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of PWO? 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 for every stock on the FRA every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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