Does Krakchemia SA (WSE:KCH) share price in March reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by projecting its future cash flows and then discounting them to the present value. Our analysis will use the discounted cash flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.

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

See our latest analysis for Krakchemia

Step by step in the calculation

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To start, we need to estimate the cash flows for the next ten years. Since no analyst estimate of free cash flow is available, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported value. 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 more in early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:

Estimated free cash flow (FCF) over 10 years

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = 4.0 million zł

We now need to calculate the terminal value, which represents all future cash flows after this 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 10-year government bond yield of 2.5%. We discount terminal cash flows to present value at a cost of equity of 11%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = zł509k× (1 + 2.5%) ÷ (11%– 2.5%) = zł6.1m

Present value of terminal value (PVTV)= TV / (1 + r)^ten= zł6.1m÷ ( 1 + 11%)^ten= zł2.2m

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 6.2 million zł. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 0.6 zł, the company appears approximately at fair value at an 18% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.

The hypotheses

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 consider Krakchemia 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 11%, which is based on a leveraged beta of 1.679. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Let’s move on :

Although a business valuation is important, it is only one of many factors you need to assess for a business. The DCF model is not a perfect stock valuation tool. Instead, the best use of 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 pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Krakchemia, we’ve put together three important things you should consider:

1. Risks: For example, we have identified 2 warning signs for Krakchemia (1 is potentially serious) of which you should be aware.
2. 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 strong trading fundamentals to see if there are any other companies you may not have considered!
3. Other top analyst picks: Interested to see what the analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think could have attractive future prospects!

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

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.