How far is Solvac SA (EBR: SOLV) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock’s price is fair by projecting its future cash flows and then discounting them to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.
See our latest analysis for Solvac
What is the estimated valuation?
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 a lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. 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 discount the value of those future cash flows to their estimated value in today’s dollars. hui:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (â¬, Millions)||114.9 M â¬||â¬ 113.9m||â¬ 113.6m||â¬ 113.8m||114.4 M â¬||â¬ 115.2m||â¬ 116.3m||â¬ 117.4m||118.7 M â¬||â¬ 120.0m|
|Source of growth rate estimate||Is @ -1.79%||East @ -0.88%||East @ -0.25%||Is @ 0.2%||Is @ 0.51%||East @ 0.73%||Is @ 0.88%||East @ 0.99%||East @ 1.07%||Est @ 1.12%|
|Present value (â¬, Millions) discounted at 6.5%||â¬ 108||100 â¬||â¬ 94.0||â¬ 88.5||â¬ 83.5||â¬ 79.0||â¬ 74.8||â¬ 70.9||â¬ 67.3||â¬ 63.9|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 830 M â¬
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.2%) to estimate future growth. Similar to the 10-year âgrowthâ period, we discount future cash flows to their present value, using a cost of equity of 6.5%.
Terminal value (TV)= FCF2031 Ã (1 + g) Ã· (r – g) = â¬ 120m Ã (1 + 1.2%) Ã· (6.5% – 1.2%) = â¬ 2.3bn
Present value of terminal value (PVTV)= TV / (1 + r)ten= â¬ 2.3bn Ã· (1 + 6.5%)ten= â¬ 1.2bn
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 2.1 billion euros. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current market price of â¬ 116, the company appears to be around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
We would like to stress that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 full picture of a company’s potential performance. Since we view Solvac as 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 6.5%, which is based on a leveraged beta of 0.991. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
While important, calculating DCF shouldn’t be the only metric you look at when looking for 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. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Solvac, there are three relevant elements that you should research further:
- Risks: You should be aware of the 3 warning signs for Solvac (2 are potentially serious!) We found out before considering an investment in the business.
- 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 else you might be missing!
- Other environmentally friendly companies: Are you concerned about the environment and think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover stocks you may not have thought of!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each ENXTBR share. If you want to find the calculation for other actions, do a search here.
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This Simply Wall St article is general in nature. 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 material. Simply Wall St has no position in any of the stocks mentioned.
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