Stock Analysis

Are Investors Undervaluing Nestlé S.A. (VTX:NESN) By 38%?

SWX:NESN
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Key Insights

  • The projected fair value for Nestlé is CHF147 based on 2 Stage Free Cash Flow to Equity
  • Nestlé is estimated to be 38% undervalued based on current share price of CHF91.72
  • The CHF106 analyst price target for NESN is 28% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Nestlé S.A. (VTX:NESN) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Nestlé

What's The Estimated Valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (CHF, Millions) CHF12.2b CHF12.5b CHF13.4b CHF13.8b CHF14.1b CHF14.3b CHF14.4b CHF14.5b CHF14.6b CHF14.7b
Growth Rate Estimate Source Analyst x8 Analyst x7 Analyst x2 Est @ 2.67% Est @ 1.93% Est @ 1.40% Est @ 1.04% Est @ 0.79% Est @ 0.61% Est @ 0.48%
Present Value (CHF, Millions) Discounted @ 3.9% CHF11.7k CHF11.6k CHF12.0k CHF11.9k CHF11.6k CHF11.4k CHF11.1k CHF10.7k CHF10.4k CHF10.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CHF112b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (0.2%) 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 3.9%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CHF15b× (1 + 0.2%) ÷ (3.9%– 0.2%) = CHF400b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CHF400b÷ ( 1 + 3.9%)10= CHF274b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CHF386b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CHF91.7, the company appears quite undervalued at a 38% 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.

dcf
SWX:NESN Discounted Cash Flow July 1st 2024

The Assumptions

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 Nestlé 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 3.9%, 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.

SWOT Analysis for Nestlé

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Food market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to grow slower than the Swiss market.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. What is the reason for the share price sitting below the intrinsic value? For Nestlé, we've compiled three relevant items you should further examine:

  1. Risks: For example, we've discovered 1 warning sign for Nestlé that you should be aware of before investing here.
  2. Future Earnings: How does NESN'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.
  3. 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SWX every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we're here to simplify it.

Discover if Nestlé might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.