Today we are going to take a simple walkthrough of a valuation method used to estimate the attractiveness of Azelis Group NV (EBR:AZE) as an investment opportunity by taking expected future cash flows and discounting them to their current value. One way to do this is to use the discounted cash flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
See our latest analysis for Azelis Group
Step by step in the calculation
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. 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.
Generally, we assume that a dollar today is worth more than a dollar in the future, 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 (€, Millions)||€194.0m||€217.0m||€235.0m||€247.8 million||€258.0m||€266.3 million||€273.1 million||€278.9 million||€284.0 million||€288.5 million|
|Growth rate estimate Source||Analyst x1||Analyst x1||Analyst x1||Is at 5.44%||Is at 4.13%||Is at 3.21%||Is at 2.57%||Is at 2.12%||Is at 1.8%||Is at 1.58%|
|Present value (€, millions) discounted at 6.7%||182 €||190 €||193 €||191 €||186 €||180 €||173 €||165 €||158 €||150 €|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = €1.8 billion
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which 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 (1.1%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.7%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = €288m × (1 + 1.1%) ÷ (6.7%– 1.1%) = €5.1bn
Present value of terminal value (PVTV)= TV / (1 + r)ten= €5.1 billion÷ ( 1 + 6.7%)ten= €2.7 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 4.4 billion euros. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of €24.3, the company appears slightly overvalued at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.
We emphasize 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 complete picture of a company’s potential performance. Since we consider Azelis Group 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 6.7%, which is based on a leveraged beta of 1.172. 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.
Although important, the DCF calculation is just one of many factors you need to assess for a business. It is not possible to obtain an infallible 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 the company being undervalued or overvalued. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. What is the reason why the stock price exceeds the intrinsic value? For Azelis Group, we have compiled three relevant elements for you to assess:
- Risks: You should be aware of the 2 warning signs for Azelis Group we found out before considering an investment in the business.
- Future earnings: How does AZE’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Belgian stock daily, so if you want to find the intrinsic value of any other stock, just search here.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.