Yahoo Finance Investors Are Undervaluing REN – Redes Energéticas Nacionais SGPS SA (ELI:RENE) By 21.49%
Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of REN – Redes Energéticas Nacionais SGPS SA (ELI:RENE) as an investment opportunity by taking the expected future cash flows and discounting them to today’s value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for REN – Redes Energéticas Nacionais SGPS by following the link below. View out our latest analysis for REN – Redes Energéticas Nacionais SGPS
What’s the value?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To start off with we need to estimate the next five years of cash flows. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
2018 | 2019 | 2020 | 2021 | 2022 | |
Levered FCF (€, Millions) | €222.44 | €217.57 | €222.89 | €245.00 | €242.08 |
Source | Analyst x4 | Analyst x4 | Analyst x3 | Analyst x2 | Extrapolated @ (-1.19%) |
Present Value Discounted @ 12.72% | €197.34 | €171.25 | €155.64 | €151.78 | €133.05 |
Present Value of 5-year Cash Flow (PVCF)= €809.06m
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (1.5%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 12.7%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €242.08m × (1 + 1.5%) ÷ (12.7% – 1.5%) = €2.19b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €2.19b ÷ ( 1 + 12.7%)5 = €1.21b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €2.01b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of €3.04. Relative to the current share price of €2.38, the stock is about right, perhaps slightly undervalued at a 21.49% discount to what it is available for right now.
Important assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at REN – Redes Energéticas Nacionais SGPS as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 12.7%, which is based on a levered beta of 1.32. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For RENE, I’ve put together three important aspects you should further examine:
Financial Health: Does RENE have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does RENE’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.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of RENE? 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 does a DCF calculation for every PT stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
