Telecom Italia SpA (BIT:TIT) Is Trading At A 32.52% Discount

Does the share price for Telecom Italia SpA (BIT:TIT) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in June 2018 so be sure check out the updated calculation by following the link below. See our latest analysis for Telecom Italia

Crunching the numbers

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

2018	2019	2020	2021	2022
Levered FCF (€, Millions)	€2.24k	€2.33k	€2.45k	€2.28k	€2.35k
Source	Analyst x5	Analyst x8	Analyst x9	Analyst x2	Analyst x1
Present Value Discounted @ 12.28%	€1.99k	€1.85k	€1.73k	€1.43k	€1.32k

Present Value of 5-year Cash Flow (PVCF)= €8.33b

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 (1.8%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 12.3%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = €2.35b × (1 + 1.8%) ÷ (12.3% – 1.8%) = €22.83b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = €22.83b ÷ ( 1 + 12.3%)⁵ = €12.80b

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 €21.12b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of €1. Relative to the current share price of €0.68, the stock is quite undervalued at a 32.52% discount to what it is available for right now.

BIT:TIT Intrinsic Value June 22nd 18

The assumptions

I’d like to point out that 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Telecom Italia 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 12.3%, which is based on a levered beta of 1.277. 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 TIT, there are three essential aspects you should further examine:

1. Financial Health: Does TIT 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 TIT’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 TIT? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the BIT every 6 hours. If you want to find the calculation for other stocks 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.