Today we are going to review a valuation method used to estimate the attractiveness of Cnova NV (EPA: CNV) as an investment opportunity by taking the company’s future cash flow forecast and by updating 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.
There are many ways that businesses can be assessed, so we would like to stress that a DCF is not perfect for all situations. If you still have burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
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We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. 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 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) forecast
|Leverage FCF (€, Millions)||€ 103.8m||€ 116.7m||€ 127.0m||€ 135.0m||€ 141.1m||€ 145.6m||149.1 M €||151.8 M €||€ 153.8m||155.5 M €|
|Source of growth rate estimate||Est @ 17.59%||Is 12.42%||East @ 8.8%||East @ 6.27%||Is 4.5%||East @ 3.26%||East @ 2.39%||East @ 1.78%||Est @ 1.35%||East @ 1.06%|
|Present value (€, Millions) discounted @ 5.7%||€ 98.3||105 €||€ 108||€ 108||107 €||105 €||€ 101||€ 97.8||€ 93.8||€ 89.7|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 1.0 billion euros
The next step is to calculate the Terminal Value, which takes into account all future cash flows after this ten-year period. 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 (0.4%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 5.7%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = € 155m × (1 + 0.4%) ÷ (5.7% – 0.4%) = € 2.9bn
Present value of terminal value (PVTV)= TV / (1 + r)ten= € 2.9bn ÷ (1 + 5.7%)ten= € 1.7bn
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 2.7 billion euros. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current stock price of € 9.2, the company appears to be around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual 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 full picture of a company’s potential performance. Since we view Cnova 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 5.7%, which is based on a leveraged beta of 1.121. 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.
To move on :
While valuing a business is important, it’s just one of the many factors you need to assess for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” 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. For Cnova, we have compiled three relevant elements to take into account:
- Risks: We think you should evaluate the 2 warning signs for Cnova (1 doesn’t suit us too much!) We reported before investing in the company.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you might not have considered!
- Other picks from top analysts: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!
PS. Simply Wall St updates its DCF calculation for every French stock every day, so if you want to find the intrinsic value of another stock just 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 the mentioned stocks.
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