Today we are going to do a simple overview of a valuation method used to estimate the attractiveness of GCC, SAB de CV (BMV:GCC) as an investment opportunity by taking the flows of expected future cash flows and discounting them to their present value. One way to do this is to use the discounted cash flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
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Is GCC. by Rated Enough?
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 begin with, we need to obtain cash flow estimates 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-Year Free Cash Flow (FCF) Forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF ($, millions) | $230.3 million | $235.4 million | $234.1 million | $247.1 million | $256.1 million | $268.1 million | $282.8 million | $299.8 million | $318.9 million | $340.0 million |
Growth rate estimate Source | Analyst x2 | Analyst x2 | Analyst x1 | Analyst x1 | Is at 3.63% | Is at 4.71% | Is at 5.47% | Is at 6% | Is at 6.37% | Is at 6.63% |
Present value (in millions of dollars) discounted at 13% | $204 | $185 | $163 | $153 | $141 | $131 | $122 | $115 | $108 | $103 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $1.4 billion
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 stage. 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 7.2%. We discount terminal cash flows to present value at a cost of equity of 13%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = US$340 million × (1 + 7.2%) ÷ (13%–7.2%) = US$6.6 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $6.6 billion ÷ (1 + 13%)^{ten}= US$2.0 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $3.4 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current stock price of Mex$114, the company looks quite undervalued at a 45% discount to the current stock 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.
Important assumptions
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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we are looking at GCC. 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 factors in debt. In this calculation, we used 13%, which is based on a leveraged beta of 0.943. 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:
Although a business valuation is important, it is only one of many factors you need to assess for a business. It is not possible to obtain an infallible 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?” For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is intrinsic value higher than the current stock price? For GCC. de, we’ve rounded up three essentials you should dig deeper into:
- Financial health: Does GCC* 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 GCC*’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. The Simply Wall St app performs a discounted cash flow valuation for every stock on the BMV every day. If you want to find the calculation for other stocks, 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.
Calculation of discounted cash flows for each share
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