CEZ, a. s.'s (SEP:CEZ) Intrinsic Value Is Potentially 29% Above Its Share Price

Key Insights

• CEZ a. s' estimated fair value is Kč1.2k based on 2 Stage Free Cash Flow to Equity
• Current share price of Kč920 suggests CEZ a. s is 23% undervalued
• Analyst price target for CEZ is Kč978 which is 18% below our fair value estimate

Does the January share price for CEZ, a. s. (SEP:CEZ) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present 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 would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for CEZ a. s

The Model

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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CZK, Millions)	Kč44.9b	Kč36.8b	Kč36.9b	Kč58.9b	Kč49.3b	Kč44.0b	Kč41.0b	Kč39.2b	Kč38.3b	Kč37.9b
Growth Rate Estimate Source	Analyst x6	Analyst x4	Analyst x3	Analyst x5	Analyst x3	Est @ -10.77%	Est @ -6.93%	Est @ -4.25%	Est @ -2.37%	Est @ -1.05%
Present Value (CZK, Millions) Discounted @ 7.5%	Kč41.7k	Kč31.8k	Kč29.7k	Kč44.1k	Kč34.4k	Kč28.5k	Kč24.7k	Kč22.0k	Kč20.0k	Kč18.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = Kč295b

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 (2.0%) 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)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = Kč38b× (1 + 2.0%) ÷ (7.5%– 2.0%) = Kč706b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= Kč706b÷ ( 1 + 7.5%)¹⁰= Kč342b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is Kč638b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of Kč920, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

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. 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 CEZ a. s 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 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 CEZ a. s

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 CEZ a. s, we've put together three additional items you should further examine:

1. Risks: To that end, you should learn about the 3 warning signs we've spotted with CEZ a. s (including 1 which can't be ignored) .
2. Future Earnings: How does CEZ'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 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEP every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.