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In this article I am going to calculate the intrinsic value of Hera SpA (BIT:HER) by taking the expected future cash flows and discounting them to today’s value. I will be using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in October 2018 so be sure check out the updated calculation by following the link below.

Check out our latest analysis for Hera

The model

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. 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)= €1.4b

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 (1.8%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 10.2%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = €405m × (1 + 1.8%) ÷ (10.2% – 1.8%) = €4.9b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = €4.9b ÷ ( 1 + 10.2%)⁵ = €3.0b

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 €4.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of €2.98. Compared to the current share price of €2.46, the stock is about right, perhaps slightly undervalued at a 18% discount to what it is available for right now.

Important 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 Hera 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 10.2%, which is based on a levered beta of 1.028. 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.