Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Carlsberg A/S (CPH:CARL B) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won’t be able to understand it, just read on! It’s actually much less complex than you’d imagine.
Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
We’re using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year free cash flow (FCF) estimate
|Levered FCF (DKK, Millions)||kr.8.07b||kr.8.19b||kr.9.12b||kr.9.69b||kr.10.1b||kr.10.4b||kr.10.6b||kr.10.8b||kr.10.9b||kr.11.0b|
|Growth Rate Estimate Source||Analyst x12||Analyst x11||Analyst x2||Analyst x2||Est @ 4.04%||Est @ 2.93%||Est @ 2.16%||Est @ 1.61%||Est @ 1.23%||Est @ 0.96%|
|Present Value (DKK, Millions) Discounted @ 5.1%||kr.7.7k||kr.7.4k||kr.7.8k||kr.7.9k||kr.7.8k||kr.7.7k||kr.7.5k||kr.7.2k||kr.6.9k||kr.6.7k|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr.75b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.3%. We discount the terminal cash flows to today’s value at a cost of equity of 5.1%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = kr.11b× (1 + 0.3%) ÷ (5.1%– 0.3%) = kr.230b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= kr.230b÷ ( 1 + 5.1%)10= kr.139b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is kr.214b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of kr.934, the company appears quite undervalued at a 36% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Carlsberg 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 accounts for debt. In this calculation we’ve used 5.1%, which is based on a levered beta of 0.800. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, the DCF calculation ideally won’t be the sole piece of analysis you scrutinize for a company. It’s not possible to obtain a foolproof valuation with a DCF model. Instead the best use for 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 significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Carlsberg, we’ve put together three relevant elements you should consider:
- Risks: Every company has them, and we’ve spotted 1 warning sign for Carlsberg you should know about.
- Future Earnings: How does CARL B’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Danish stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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