Is there an opportunity with the 49% undervaluation of CZG – Ceská zbrojovka Group SE (SEP:CZG)?
Today, we’ll walk through one way to estimate the intrinsic value of CZG – Ceská zbrojovka Group SE (SEP:CZG) by taking the company’s projected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
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We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or 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, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF (CZK, Million) | Kc1.65b | Kc1.61b | Kc1.67b | Kc1.77b | Kc1.96b | Kc2.06b | Kc2.14b | Kc2.21b | Kc2.27b | Kc2.33b |
Growth rate estimate Source | Analyst x1 | Analyst x2 | Analyst x2 | Analyst x2 | Analyst x1 | Is at 5.04% | Is at 4.01% | Is at 3.29% | Is at 2.78% | Is at 2.43% |
Present value (CZK, million) discounted at 6.6% | Kc1.5k | Kc1.4k | Kc1.4k | Kc1.4k | Kc1.4k | Kc1.4k | Kc1.4k | Kc1.3k | Kc1.3k | Kc1.2k |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = Kč14b
The second stage is also known as the 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 10-year government bond yield of 1.6%. We discount the terminal cash flows to their present value at a cost of equity of 6.6%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = Kč2.3b× (1 + 1.6%) ÷ (6.6%–1.6%) = Kč47b
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= Kč47b÷ ( 1 + 6.6%)^{ten}= Kč25b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is Kč39b. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of 583 Kč, the company looks quite undervalued at a 49% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. If you disagree with these results, try the math yourself and play around 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 complete picture of a company’s potential performance. Since we consider the CZG – Ceská zbrojovka group 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 into account the debt. In this calculation, we used 6.6%, which is based on a leveraged beta of 1.032. 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.
Look forward:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won’t be the only piece of analysis you look at for a company. DCF models are not the be-all and end-all of investment valuation. Rather, it should be seen as a guide to “what assumptions must 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, output may be very different. Why is intrinsic value higher than the current stock price? For CZG – Ceská zbrojovka Group, we have put together three additional items that you should consider in more detail:
- Risks: For example, we discovered 2 warning signs for CZG – Ceská zbrojovka Group which you should be aware of before investing here.
- Future earnings: How does CZG’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Czech 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.