Today we will make a simple run of a valuation method used to estimate the attractiveness of Cargotec Corporation (HEL: CGCBV) as an investment opportunity by planning its future cash flows and then discounting them to the value of the today. One way to achieve this is by using the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you can see from our example!
Remember, however, that there are many ways to evaluate a company’s value, and DCF is only one way. Anyone interested in learning a little more about intrinsic value should read Simply Wall St.’s analysis model.
Check out our latest analysis for Cargotec
Crunching the numbers
We are going to use a two-stage DCF model, which, as the name suggests, takes into account two growth stages. In the first stage there is a higher growth period that goes down to the value of the destination, captured in the second period ‘sustainable growth’. First we need to estimate the cash flows for the industry over the next decade. We use analysts’ estimates where possible, but where these are not available we deduct the free cash flow (FCF) from the last estimate or the reported value. . We assume that declining free cash flow companies will reduce their rate of decline, and that free cash flow companies will see their growth rate slow, over this period. . We do this to show that growth tends to be slower in the early years than in later years.
We generally assume that the dollar today is more valuable than the dollar in the future, so the sum of these future cash flows is reduced to the present value:
10-year free cash flow (FCF) forecast
| 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
| Levered FCF (€, millions) | 97.8m | 206.4m | 251.0m | 230.0m | 232.0m € | 233.5m | € 234.7m | 235.8m | 236.8m | 237.6m |
| Estimated source of growth rate | Inspector x4 | Inspector x5 | Inspector x3 | Inspector x1 | Inspector x1 | Est @ 0.64% | Est @ 0.53% | Est @ 0.46% | Est @ 0.4% | Est @ 0.37% |
| Present value (€, millions) Discount @ 7.7% | 90 € .8 | 178 € | € 201 | € 171 | 160 € | 150 € | € 140 | 131 € | 122 € | € 113 |
(“Est” = FCF growth rate measured by Simply Wall St)
Present value of 10-year Cash Flow (PVCF) = € 1.5b
The second tier is called Terminal Value, which is the cash flow of the business after the first tier. The Gordon Growth formula is used to measure Completion Value at a future annual growth rate that is equal to the 5-year average of 10-year government bond yields of 0.3%. We reduce the final cash flows to today’s value at an equity cost of 7.7%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = € 238m × (1 + 0.3%) ÷ (7.7% – 0.3%) = € 3.2b
Present value of boundary value (PVTV)= Tbh / (1 + r)10= € 3.2b ÷ (1 + 7.7%)10= € 1.5b
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is € 3.0b. To find the intrinsic value of each share, we divide this by the total number of outstanding shares. Compared to the current stock price of € 44.7, the company appears to be about fair value at a 3.9% discount to where the stock price is currently trading. Remember, however, that this is just an approximate valuation, and like any complex formula – waste in, waste out.
The assumptions
Now the most important input to discounted cash flows is the discount rate, and of course, the actual cash flows. You don’t have to agree with the submissions, I recommend repeating the numbers yourself and playing with them. The DCF also does not consider potential business cycling, or a company’s future capital requirements, and therefore does not provide a complete picture of a company’s potential performance. Since we view Cargotec as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or average weighted capital cost, WACC) resulting from debt. . In this account we have used 7.7%, which is based on a levered beta of 1.272. Beta is a measure of stock volatility, compared to the market as a whole. We get our beta from the industry average beta of comparable companies globally, with a limit of between 0.8 and 2.0, which is a reasonable range for a stable industry.
Moving On:
Evaluation is only one side of the coin when it comes to building your investment thesis, and in reality this is not the only piece of research you will do for a company. The DCF model is not a perfect stock valuation tool. Instead it should be seen as a guide to “what assumptions must be true for this stock to be under / undervalued?” For example, changes in the cost of equity of the company or the company may degree without risk of significantly affecting the valuation. For Cargotec, we’ve put together three essentials that you should look at:
- Dangers: The issue of the point, we saw 5 warning signs for Cargotec you should be aware.
- Future employment: How does the growth rate of CGCBV compare to its peers and the market in general? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectation chart.
- Other Solid Industries: Low debt, high equity yield and good past performance are fundamental to a strong business. Why not check out our interactive list of stocks with solid business foundations to see if there are other companies you haven’t thought of!
PS. Simply put, Wall St updates its DCF calculations for all Finnish stocks every day, so if you want to find the intrinsic value of any other stock just search here.
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