Today we are going to do a simple overview of a valuation method used to estimate the attractiveness of Novozymes A/S (CPH:NZYM B) as an investment opportunity by taking the flows of expected future cash flows and discounting them to their present value. This will be done using the discounted cash flow (DCF) model. This may sound complicated, but it’s actually quite simple!
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.
See our latest review for Novozymes
What is the estimated valuation?
We use what is called a 2-stage 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 start, we need to estimate the cash flows 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, and so the sum of these future cash flows is then discounted to today’s value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF (DKK, Millions)||1.90 kr||kr.2.75b||kr.3.54b||kr.4.07b||kr.4.36b||kr.4.56b||kr.4.71b||kr.4.81b||kr.4.89b||kr.4.95b|
|Growth rate estimate Source||Analyst x9||Analyst x13||Analyst x10||Analyst x3||Analyst x2||Is at 4.53%||Is at 3.2%||Is at 2.27%||Is at 1.61%||Is at 1.16%|
|Present value (DKK, million) discounted at 4.3%||kr.1.8k||kr.2.5k||kr.3.1k||kr.3.4k||kr.3.5k||kr.3.5k||kr.3.5k||kr.3.4k||kr.3.4k||kr.3.3k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = kr.32b
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. 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 0.09%. We discount terminal cash flows to present value at a cost of equity of 4.3%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = kr.4.9b × (1 + 0.09%) ÷ (4.3%– 0.09%) = kr.118b
Present value of terminal value (PVTV)= TV / (1 + r)ten= kr.118b÷ ( 1 + 4.3%)ten= kr.78b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is 110 kr. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of kr.462, the company appears around fair value at the time of writing. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 Novozymes 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 4.3%, which is based on a leveraged beta of 0.986. 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.
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won’t be the only piece of analysis you look at for a company. The DCF model is not a perfect stock valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. For Novozymes, we’ve compiled three additional factors you should explore:
- Financial health: Does NZYM B have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
- Future earnings: How does NZYM B’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 high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Danish stock daily, so if you want to find the intrinsic value of any other stock, 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 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.