A look at the fair value of Saipem SpA (BIT:SPM)

Key findings

• The forecast fair value for Saipem is €2.37 based on the 2-step Free Cash Flow to Equity
• Saipem’s share price of €2.37 suggests that the price is at a similar level to the estimated fair value
• Our fair value estimate is 18% below Saipem’s analyst price target of €2.87

How far is Saipem SpA (BIT:SPM) from its intrinsic value? Using the most recent financial data, we will check whether the stock is fairly valued by taking the expected future cash flows and discounting them to their present value. Our analysis will use the Discounted Cash Flow (DCF) model. There is actually not too much to it, even though it may seem quite complex.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. For those who enjoy stock analysis, the analysis model presented here by Simply Wall St might be of interest.

Check out our latest analysis for Saipem

What is the estimated value?

We use the two-stage growth model, which simply means that we consider two stages of the company’s growth. In the early stage, the company might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to get estimates of the next ten years of cash flows. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, the sum of these future cash flows is discounted to today’s value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 3.2 billion euros

The second period is also called the terminal value. This is the company’s cash flow after the first period. For various reasons, a very conservative growth rate is used, which cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year Treasury yield (2.3%) 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 13%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = €515 million × (1 + 2.3%) ÷ (13% – 2.3%) = €5.0 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= €5.0 billion ÷ (1 + 13%)¹⁰= 1.5 billion euros

The total value or equity value is then the sum of the present value of future cash flows, which in this case is 4.7 billion euros. To get the intrinsic value per share, we divide this by the total number of shares issued. Compared to the current share price of 2.4 euros, the company appears to be roughly fairly valued at a discount of 0.03% to the current share price. However, keep in mind that this is only an approximate valuation and as with any complex formula, where there is rubbish in, there is rubbish out.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs, and therefore does not provide a complete picture of a company’s potential performance. Since we consider Saipem 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 debt into account. In this calculation, we used 13%, which is based on a leveraged beta of 1.346. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies, with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Saipem

Go on:

While a company’s valuation is important, it is only one of many factors you need to evaluate a company. DCF models are not the be-all and end-all of investment valuation. Rather, they should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued.” For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. For Saipem, we have compiled three essential elements for you to consider:

1. Financial health: Does SPM have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks for key factors such as debt and risk.
2. Future income: How does SPM’s growth rate compare to competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for each Italian stock daily, so if you want to find out the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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