Are investors undervaluing Aker Solutions ASA (OB:AKSO) by 35%?

In this article, we are going to estimate the intrinsic value of Aker Solutions ASA (OB:AKSO) by taking the expected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.

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. 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.

Check out our latest analysis for Aker Solutions

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. In the first step, we need to estimate the company’s cash flow over 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.

Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:

10-Year Free Cash Flow (FCF) Forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF (NOK, Million) kr1.18b kr1.53b kr1.74b kr1.88b kr2.00b kr2.09b kr2.17b kr2.23b kr2.28b kr2.33b
Growth rate estimate Source Analyst x4 Analyst x4 Analyst x1 Is at 8.42% Is at 6.22% Is at 4.68% Is at 3.6% Is at 2.85% Is at 2.32% Is 1.95%
Present value (NOK, millions) discounted at 7.8% kr1.1k kr1.3k kr1.4k kr1.4k kr1.4k kr1.3k kr1.3k kr1.2k kr1.2k kr1.1k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = kr13b

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 1.1%. We discount the terminal cash flows to their present value at a cost of equity of 7.8%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = kr2.3b × (1 + 1.1%) ÷ (7.8%–1.1%) = kr35b

Present value of terminal value (PVTV)= TV / (1 + r)ten= kr35b÷ ( 1 + 7.8%)ten= kr16b

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 29 kr. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 38.4 kr, the company looks quite undervalued at a 35% discount to the current share price. 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.

OB: AKSO Discounted Cash Flow September 23, 2022

The hypotheses

Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Aker Solutions 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 7.8%, which is based on a leveraged beta of 1.594. 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, the DCF calculation will ideally not be the only piece of analysis you look at for 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. Why is intrinsic value higher than the current stock price? For Aker Solutions, we’ve compiled three fundamentals you should consider:

  1. Financial health: Does AKSO 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.
  2. Management:Did insiders increase their shares to take advantage of market sentiment about AKSO’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.
  3. 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. The Simply Wall St app performs an updated cash flow valuation for every stock on the OB every day. If you want to find the calculation for other stocks, search here.

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.

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About Myra R.

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