An Intrinsic Calculation For Eurocash S.A. (WSE:EUR) Suggests It's 43% Undervalued

Key Insights

• The projected fair value for Eurocash is zł10.72 based on 2 Stage Free Cash Flow to Equity
• Eurocash's zł6.13 share price signals that it might be 43% undervalued
• Our fair value estimate is 1.1% higher than Eurocash's analyst price target of zł10.60

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Eurocash S.A. (WSE:EUR) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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The Method

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 begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (PLN, Millions)	zł415.3m	zł413.5m	zł198.0m	zł156.9m	zł136.4m	zł125.9m	zł121.0m	zł119.4m	zł120.1m	zł122.3m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x1	Est @ -20.76%	Est @ -13.07%	Est @ -7.69%	Est @ -3.92%	Est @ -1.28%	Est @ 0.56%	Est @ 1.85%
Present Value (PLN, Millions) Discounted @ 15%	zł362	zł313	zł131	zł90.2	zł68.2	zł54.9	zł45.9	zł39.4	zł34.5	zł30.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł1.2b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (4.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 15%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = zł122m× (1 + 4.9%) ÷ (15%– 4.9%) = zł1.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł1.3b÷ ( 1 + 15%)¹⁰= zł322m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł1.5b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of zł6.1, the company appears quite undervalued at a 43% discount to where the stock price trades currently. 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.

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Eurocash 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 15%, which is based on a levered beta of 1.828. 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.

See our latest analysis for Eurocash

SWOT Analysis for Eurocash

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. Why is the intrinsic value higher than the current share price? For Eurocash, there are three further aspects you should explore:

1. Risks: Every company has them, and we've spotted 1 warning sign for Eurocash you should know about.
2. Future Earnings: How does EUR's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every Polish stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.