In this article we are going to estimate the intrinsic value of BE Semiconductor Industries N.V. (AMS:BESI) by taking the expected future cash flows and discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
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.
Is BE Semiconductor Industries fairly valued?
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. To begin with, we have to get estimates of the next ten years of cash flows. 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 (€, Millions)||€149.0m||€181.5m||€204.7m||€223.2m||€237.6m||€248.6m||€256.8m||€263.1m||€267.9m||€271.5m|
|Growth Rate Estimate Source||Analyst x2||Analyst x2||Est @ 12.78%||Est @ 9.05%||Est @ 6.44%||Est @ 4.61%||Est @ 3.33%||Est @ 2.44%||Est @ 1.81%||Est @ 1.37%|
|Present Value (€, Millions) Discounted @ 7.5%||€139||€157||€165||€167||€166||€161||€155||€148||€140||€132|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €1.5b
We now need to calculate the Terminal Value, which accounts for all the 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 have used the 5-year average of the 10-year government bond yield (0.4%) to estimate future growth. In the same way as with the 10-year ‘growth’ period, we discount future cash flows to today’s value, using a cost of equity of 7.5%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = €272m× (1 + 0.4%) ÷ (7.5%– 0.4%) = €3.8b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €3.8b÷ ( 1 + 7.5%)10= €1.9b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €3.4b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €38.5, the company appears about fair value at a 18% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope – move a few degrees and end up in a different galaxy. Do keep this in mind.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company’s future performance, so try the calculation yourself and check your own assumptions. 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 BE Semiconductor Industries 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 7.5%, which is based on a levered beta of 1.184. 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.
Although the valuation of a company is important, it ideally won’t be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to “what assumptions need to be true for this stock to be under/overvalued?” For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For BE Semiconductor Industries, there are three fundamental aspects you should further examine:
- Risks: Case in point, we’ve spotted 2 warning signs for BE Semiconductor Industries you should be aware of.
- Future Earnings: How does BESI’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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every Dutch 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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