Today we are going to take a simple overview of a valuation method used to estimate the attractiveness of Culti Milano SpA (BIT: CULT) as an investment opportunity by estimating future cash flows. of the company and discounting them to their current value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
We would like to point out that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who are thoroughly learning equity analysis, the Simply Wall St analysis template here may interest you.
Discover our latest analysis for Culti Milano
The model
We use what is called a 2-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. First, we need to estimate the cash flow of the business over the next ten years. Since no analysts estimate of free cash flow is available to us, we have extrapolated past free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to present value:
10-year free cash flow (FCF) estimate
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF (€, million) | 3.33 M € | € 4.12m | € 4.84m | € 5.45 million | € 5.96m | 6.38 million euros | 6.73 million euros | € 7.03 million | 7.28 million euros | 7.51 million euros |
Source of estimated growth rate | Is 33.39% | Is 23.91% | Is at 17.27% | Is 12.63% | Is 9.38% | Is 7.1% | Is 5.51% | Is 4.39% | Is 3.61% | Is 3.07% |
Present value (€, million) discounted at 9.0% | € 3.1 | 3.5 € | 3,7 € | € 3.9 | € 3.9 | € 3.8 | 3,7 € | 3.5 € | € 3.4 | € 3.2 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 35 M €
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. Gordon’s growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.8%. We discount the terminal cash flows to their present value at a cost of equity of 9.0%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = 7.5 million euros × (1 + 1.8%) ÷ (9.0% – 1.8%) = 106 million euros
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= € 106m ÷ (1 + 9.0%)^{ten}= 45 M €
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which translates into the Total Equity Value, which in this case is € 80m. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of 8.3 €, the company appears potentially undervalued with a discount of more than 50%. For me this is not a good thing, we should try to understand why the stock looks cheap in this model. Do the inputs we used seem reasonable? Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
The hypotheses
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. Part of investing is making your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Culti Milano 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 takes debt into account. In this calculation, we used 9.0%, which is based on a leveraged beta of 1.048. Beta is a measure of the volatility of a stock, relative 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.
Looking forward:
While a business valuation is important, ideally, it won’t be the only analysis you look at for a business. DCF models are not the alpha and omega of investment valuation. Preferably, you would apply different cases and assumptions and see how they would impact the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. What is the reason why the stock price is lower than intrinsic value? For Culti Milano, you must take into account three fundamental elements:
- Risks: For example, we have identified 3 warning signs for Culti Milano that you need to be aware of.
- Future income: How does CULT’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality inventory to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every ILO share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in the mentioned stocks.
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