A Look At The Intrinsic Value Of Itera ASA (OB:ITE)
Simply Wall St
Does the April share price for Itera ASA (OB:ITE) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This is done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow are will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
Levered FCF (NOK, Millions)
NOK38.14
NOK38.95
NOK39.74
NOK40.51
NOK41.27
NOK42.03
NOK42.80
NOK43.57
NOK44.35
NOK45.14
Growth Rate Estimate Source
Est @ 2.28%
Est @ 2.13%
Est @ 2.02%
Est @ 1.94%
Est @ 1.89%
Est @ 1.85%
Est @ 1.82%
Est @ 1.8%
Est @ 1.79%
Est @ 1.78%
Present Value (NOK, Millions) Discounted @ 8.23%
NOK35.24
NOK33.25
NOK31.34
NOK29.52
NOK27.79
NOK26.15
NOK24.60
NOK23.14
NOK21.76
NOK20.47
Present Value of 10-year Cash Flow (PVCF)= NOK273.27m
"Est" = FCF growth rate estimated by Simply Wall St
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = NOKøre710m ÷ ( 1 + 8.2%)10 = NOK321.91m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NOK595.18m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value estimate of NOK7.35. Relative to the current share price of NOK8.54, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
OB:ITE Intrinsic value, April 29th 2019
The assumptions
Now 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 result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Itera 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 accounts for debt. In this calculation we've used 8.2%, which is based on a levered beta of 1.086. Beta is a measure of a stock's volatility, compared 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.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Itera, I've compiled three pertinent aspects you should further examine:
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of ITE? 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 valuation for every stock on the OB every day. If you want to find the calculation for other stocks just search here.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
