A Look At The Fair Value Of Solvac S.A. (EBR:SOLV)

By
Simply Wall St
Published
January 19, 2022
ENXTBR:SOLV
Source: Shutterstock

In this article we are going to estimate the intrinsic value of Solvac S.A. (EBR:SOLV) 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Solvac

Crunching the numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (€, Millions) €116.0m €115.8m €116.0m €116.5m €117.3m €118.3m €119.4m €120.5m €121.8m €123.1m
Growth Rate Estimate Source Est @ -0.83% Est @ -0.23% Est @ 0.18% Est @ 0.47% Est @ 0.68% Est @ 0.82% Est @ 0.92% Est @ 0.99% Est @ 1.04% Est @ 1.07%
Present Value (€, Millions) Discounted @ 6.0% €109 €103 €97.4 €92.3 €87.7 €83.4 €79.4 €75.6 €72.1 €68.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €869m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.0%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = €123m× (1 + 1.2%) ÷ (6.0%– 1.2%) = €2.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €2.6b÷ ( 1 + 6.0%)10= €1.4b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €2.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €113, the company appears around fair value at the time of writing. 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.

dcf
ENXTBR:SOLV Discounted Cash Flow January 19th 2022

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Solvac 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 6.0%, which is based on a levered beta of 0.991. 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.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Solvac, there are three pertinent items you should look at:

  1. Risks: Take risks, for example - Solvac has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
  2. 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!
  3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. Simply Wall St updates its DCF calculation for every Belgian stock every day, so if you want to find the intrinsic value of any other stock just search here.

Discounted cash flow calculation for every stock

Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.

Make Confident Investment Decisions

Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
Find out more about our editorial guidelines and team.