Does the December share price for Trakcja PRKiI SA (WSE: TRK) reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to today’s value. Our analysis will use 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.

Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.

Check out our latest review for Trakcja PRKiI

What is the estimated valuation?

We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.

Generally, 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 today’s value:

10-year Free Cash Flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leverage FCF (PLN, Millions) zł11.3m zł12.4m zł13.3m zł14.1m zł14.8m zł15.4m zł16.0m zł16.5m zł17.0m zł17.5m
Source of estimated growth rate Est @ 12.46% East @ 9.47% East @ 7.37% Est @ 5.91% Est @ 4.88% East @ 4.17% East @ 3.66% East @ 3.31% East @ 3.06% East @ 2.89%
Present value (PLN, millions) discounted at 13% zł10.1 zł9.8 zł9.3 zł8.8 zł8.2 zł7.5 zł6.9 zł6.4 zł5.8 zł5.3

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = zł78m

The second stage is also known as terminal value, it is the cash flow of the business after the first stage. The Gordon 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 2.5%. We discount the terminal cash flows to their present value at a cost of equity of 13%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = zł18m × (1 + 2.5%) ÷ (13% – 2.5%) = zł176m

Present value of terminal value (PVTV)= TV / (1 + r)ten= zł176m ÷ (1 + 13%)ten= zł53m

Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is z131 million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current stock price of 1.8z, the company appears to be around fair value at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.

WSE Discounted Cash Flows: TRK December 15, 2021

Important assumptions

We draw your attention to the fact 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 these results, try the calculation yourself and play with the 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 full picture of a company’s potential performance. Since we consider Trakcja PRKiI 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 13%, which is based on a leveraged beta of 2,000. 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 comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. DCF models are not the ultimate solution for investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Trakcja PRKiI, you have to assess three fundamental elements:

  1. Risks: Know that Trakcja PRKiI displays 3 warning signs in our investment analysis , and 1 of them is a bit rude …
  2. Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
  3. Other picks from top analysts: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each WSE share. If you want to find the calculation for other actions, just search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is 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 documents. Simply Wall St has no position in any of the stocks mentioned.

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