Estimating The Intrinsic Value Of EDAG Engineering Group AG (ETR:ED4)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, EDAG Engineering Group fair value estimate is €13.30

• With €10.95 share price, EDAG Engineering Group appears to be trading close to its estimated fair value

• The €14.33 analyst price target for ED4 is 7.7% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of EDAG Engineering Group AG (ETR:ED4) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for EDAG Engineering Group

The Model

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 begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (€, Millions)	€7.70m	€15.1m	€22.5m	€26.8m	€30.3m	€33.2m	€35.5m	€37.3m	€38.6m	€39.7m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 18.91%	Est @ 13.41%	Est @ 9.55%	Est @ 6.86%	Est @ 4.97%	Est @ 3.64%	Est @ 2.72%
Present Value (€, Millions) Discounted @ 9.8%	€7.0	€12.5	€17.0	€18.4	€19.0	€19.0	€18.5	€17.7	€16.7	€15.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €162m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 9.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = €40m× (1 + 0.6%) ÷ (9.8%– 0.6%) = €434m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €434m÷ ( 1 + 9.8%)¹⁰= €171m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €333m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €11.0, the company appears about fair value at a 18% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 EDAG Engineering 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 accounts for debt. In this calculation we've used 9.8%, which is based on a levered beta of 2.000. 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 EDAG Engineering Group

Strength

• Debt is not viewed as a risk.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• Earnings growth over the past year underperformed the Auto Components industry.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

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

Threat

• Dividends are not covered by cash flow.

• Annual earnings are forecast to grow slower than the German market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For EDAG Engineering Group, we've put together three additional factors you should further research:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with EDAG Engineering Group , and understanding it should be part of your investment process.

2. Future Earnings: How does ED4'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the XTRA every day. If you want to find the calculation for other stocks 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.