In this article, we will estimate the intrinsic value of Polski Koncern Naftowy ORLEN Spólka Akcyjna (WSE:PKN) by taking the expected future cash flows of the business and discounting them to the present value. We will use the Discounted Cash Flow (DCF) model for this purpose. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
Check out our latest analysis for Polski Koncern Naftowy ORLEN Spólka Akcyjna
The model
We use what is called a 2-step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
| 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
| Leveraged FCF (PLN, Millions) | 532.2 million zł | -46.5 million zł | 696.0 million zł | 2.79 zł | 3.45 zł | 3.95 zł | 4.38 zł | 4.75 zł | 5.07 zł | 5.34 zł |
| Growth rate estimate Source | Analyst x6 | Analyst x6 | Analyst x5 | Analyst x5 | Analyst x5 | Is at 14.52% | Is at 10.9% | Is at 8.37% | Is at 6.6% | Is at 5.36% |
| Present value (PLN, millions) discounted at 11% | 479 zł | -37.6 zł | 507 zł | 1,800 zł | zł2.0k | zł2.1k | zł2.1k | zł2.0k | zł2.0k | 1,900 zł |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = zł15b
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 2.5%. We discount terminal cash flows to present value at a cost of equity of 11%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = zł5.3b × (1 + 2.5%) ÷ (11%–2.5%) = zł63b
Present value of terminal value (PVTV)= TV / (1 + r)ten= zł63b÷ ( 1 + 11%)ten= zł22b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 37 billion zł. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 69.9 zł, the company appears approximately at fair value at a 19% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Polski Koncern Naftowy ORLEN Spólka Akcyjna 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 into account the debt. In this calculation, we used 11%, which is based on a leveraged beta of 1.706. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Next steps:
While important, calculating DCF shouldn’t be the only metric to consider when researching a business. DCF models are not the be-all and end-all of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. For Polski Koncern Naftowy ORLEN Spólka Akcyjna, there are three important things you should dig into:
- Risks: To this end, you should inquire about the 2 warning signs we spotted with Polski Koncern Naftowy ORLEN Spólka Akcyjna (including 1 which is concerning).
- Future earnings: How does PKN’s growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs an updated cash flow valuation for every stock on the WSE every day. If you want to find the calculation for other stocks, search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.