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Calculating The Intrinsic Value Of Brembo SpA (BIT:BRE)

In this article I am going to calculate the intrinsic value of Brembo SpA (BIT:BRE) by taking the expected future cash flows and discounting them to their present value. This is done using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for Brembo by following the link below.

See our latest analysis for Brembo

Step by step through the calculation

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. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow forecast

2019

2020

2021

2022

2023

Levered FCF (€, Millions)

€187.76

€229.03

€254.47

€282.74

€314.15

Source

Analyst x4

Analyst x4

Est @ 11.11%

Est @ 11.11%

Est @ 11.11%

Present Value Discounted @ 10.79%

€169.46

€186.58

€187.11

€187.64

€188.17

Present Value of 5-year Cash Flow (PVCF)= €919m

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We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.8%. We discount this to today’s value at a cost of equity of 10.8%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €314m × (1 + 1.8%) ÷ (10.8% – 1.8%) = €3.5b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €3.5b ÷ ( 1 + 10.8%)5 = €2.1b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is €3.0b. 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 €9.36. Relative to the current share price of €11.16, the stock is fair value, maybe slightly overvalued at the time of writing.

BIT:BRE Intrinsic Value Export October 6th 18
BIT:BRE Intrinsic Value Export October 6th 18

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Brembo 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 10.8%, which is based on a levered beta of 1.097. 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:

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. For BRE, there are three key factors you should further research:

  1. Financial Health: Does BRE 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.

  2. Future Earnings: How does BRE’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of BRE? 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 IT stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.