Does Akzo Nobel NV (AMS: AKZA) share price in September reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking the company’s future cash flow forecast and discounting it to today’s value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Don’t be put off by the lingo, the math is actually pretty straightforward.
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
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Is Akzo Nobel valued enough?
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. 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 stated 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 down more in the early years than in subsequent 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 the present value:
10-year Free Cash Flow (FCF) estimate
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF (€, Millions) | € 958.8m | 1.07 billion euros | 1.17 billion euros | € 1.23 billion | 1.28 billion euros | 1.31 billion euros | 1.34 billion euros | 1.35 billion euros | 1.37 billion euros | 1.38 billion euros |
Source of estimated growth rate | Analyst x10 | Analyst x8 | Analyst x3 | Analyst x2 | East @ 3.63% | Is @ 2.58% | East @ 1.84% | Est @ 1.33% | Est @ 0.97% | East @ 0.72% |
Present value (€, Millions) discounted @ 5.1% | € 912 | € 971 | € 1.0k | € 1.0k | € 997 | € 973 | € 943 | € 909 | € 874 | € 837 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = € 9.4bn
We now need to calculate the Terminal Value, which takes into account 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 of the 10-year government bond yield of 0.1%. We discount the terminal cash flows to their present value at a cost of equity of 5.1%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = 1.4 billion euros × (1 + 0.1%) ÷ (5.1% – 0.1%) = 28 billion euros
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= € 28bn ÷ (1 + 5.1%)^{ten}= € 17 billion
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 26 billion euros. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of € 100.0, the company looks fairly good value with a 31% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The hypotheses
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play with the 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 Akzo Nobel to be a potential shareholder, 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 5.1%, which is based on a leveraged beta of 1.052. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
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 business. It is not possible to achieve a rock-solid valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. What is the reason why the stock price is below intrinsic value? For Akzo Nobel, we have put together three relevant factors to consider:
- Risks: For example, we discovered 2 warning signs for Akzo Nobel which you should know before investing here.
- Future benefits: How does AKZA’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each ENXTAM share. If you want to find the calculation for other actions, just 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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