Estimating The Intrinsic Value Of DEFAMA Deutsche Fachmarkt AG (ETR:DEF)

Key Insights

• The projected fair value for DEFAMA Deutsche Fachmarkt is €27.66 based on 2 Stage Free Cash Flow to Equity

• Current share price of €25.80 suggests DEFAMA Deutsche Fachmarkt is potentially trading close to its fair value

• The average premium for DEFAMA Deutsche Fachmarkt's competitorsis currently 34%

How far off is DEFAMA Deutsche Fachmarkt AG (ETR:DEF) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. 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.

See our latest analysis for DEFAMA Deutsche Fachmarkt

Crunching The Numbers

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 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (€, Millions)	€10.7m	€10.6m	€10.6m	€10.6m	€10.6m	€10.6m	€10.7m	€10.7m	€10.8m	€10.8m
Growth Rate Estimate Source	Est @ -1.31%	Est @ -0.75%	Est @ -0.36%	Est @ -0.08%	Est @ 0.11%	Est @ 0.25%	Est @ 0.34%	Est @ 0.41%	Est @ 0.45%	Est @ 0.48%
Present Value (€, Millions) Discounted @ 8.4%	€9.9	€9.1	€8.3	€7.7	€7.1	€6.6	€6.1	€5.6	€5.2	€4.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €70m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.6%) 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 8.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = €11m× (1 + 0.6%) ÷ (8.4%– 0.6%) = €139m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €139m÷ ( 1 + 8.4%)¹⁰= €62m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €133m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of €25.8, the company appears about fair value at a 6.7% 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.

dcf

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 DEFAMA Deutsche Fachmarkt 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 8.4%, which is based on a levered beta of 1.697. 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.

SWOT Analysis for DEFAMA Deutsche Fachmarkt

Strength

• Earnings growth over the past year exceeded the industry.

Weakness

• Interest payments on debt are not well covered.

• Dividend is low compared to the top 25% of dividend payers in the Real Estate market.

Opportunity

• Annual revenue is forecast to grow faster than the German market.

• Current share price is below our estimate of fair value.

Threat

• Debt is not well covered by operating cash flow.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For DEFAMA Deutsche Fachmarkt, there are three fundamental aspects you should look at:

1. Risks: To that end, you should learn about the 4 warning signs we've spotted with DEFAMA Deutsche Fachmarkt (including 2 which are a bit unpleasant) .

2. Future Earnings: How does DEF'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every German 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.