Calculation of the intrinsic value of PagSeguro Digital Ltd. (NYSE: PAGS)
Today we are going to review one way to estimate the intrinsic value of PagSeguro Digital Ltd. (NYSE: PAGS) by taking forecasts of the company’s future cash flows and discounting them to present value. Our analysis will use the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. Anyone interested in learning a little more about intrinsic value should have a read of the Simply Wall St.
Check out our latest analysis for PagSeguro Digital
The method
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. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or the last published value. 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, so we discount the value of those future cash flows to their estimated value in today’s dollars:
10-year Free Cash Flow (FCF) forecast
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Leverage FCF (R $, millions) | -R $ 824.0 million | -R $ 980.0 million | R $ 1.77 billion | 3.72 billion R $ | R $ 5.28 billion | R $ 6.49 billion | R $ 7.57 billion | R $ 8.49 billion | R $ 9.27 billion | R $ 9.92 billion |
Source of estimated growth rate | Analyst x1 | Analyst x2 | Analyst x1 | Analyst x1 | Analyst x1 | Is 22.94% | Is 16.65% | Is at 12.25% | Is 9.18% | Est @ 7.02% |
Present value (R $, millions) with 10% discount | -R $ 748 | -808 R $ | $ 1.3K | 2.5000 R $ | $ 3.3K | $ 3.6K | $ 3.9K | $ 3.9K | $ 3.9K | $ 3.8K |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = R $ 25 billion
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. 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 2.0%. We discount terminal cash flows to their present value at a cost of equity of 10%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = R $ 9.9 billion × (1 + 2.0%) ÷ (10% – 2.0%) = R $ 124 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= R $ 124 billion ÷ (1 + 10%)^{ten}= R $ 47 billion
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is R $ 72 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 46.0, the company appears to be around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
Important assumptions
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 PagSeguro Digital 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 10%, which is based on a leveraged beta of 1.067. 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 important, the DCF calculation ideally won’t be the only analysis you look at for a business. The DCF model is not a perfect inventory valuation tool. Preferably, you apply different cases and assumptions and see how they would impact the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For PagSeguro Digital, you need to explore three relevant aspects:
- Risks: For example, we discovered 1 warning sign for PagSeguro Digital which you should be aware of before investing here.
- Future income: How does PAGS ‘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 strong companies: Low debt, high returns on equity, and good past performance are essential 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!
PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.
Promoted
If you decide to trade PagSeguro Digital, use the cheapest platform * ranked # 1 overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, currencies, bonds and funds in 135 markets, all from one integrated account.
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 any of the stocks mentioned.
^{ *}Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Annual Online Review 2020
Do you have any comments on this article? Concerned about the content? Get in touch with us directly. Otherwise, email the editorial team (at) simplywallst.com