How far off is Schaeffler AG (FRA:SHA) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today’s value. I will use the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not August 2018 then I highly recommend you check out the latest calculation for Schaeffler by following the link below.
See our latest analysis for Schaeffler
The method
I’m 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 perpetual stable growth rate. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
| 2019 | 2020 | 2021 | 2022 | 2023 | |
| Levered FCF (€, Millions) | €620.31 | €762.90 | €964.94 | €1.01k | €1.05k |
| Source | Analyst x10 | Analyst x8 | Analyst x1 | Est @ 4.36% | Est @ 4.36% |
| Present Value Discounted @ 12.38% | €551.99 | €604.10 | €679.94 | €631.45 | €586.41 |
Present Value of 5-year Cash Flow (PVCF)= €3.05b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 0.5%. We discount this to today’s value at a cost of equity of 12.4%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €1.05b × (1 + 0.5%) ÷ (12.4% – 0.5%) = €8.93b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €8.93b ÷ ( 1 + 12.4%)5 = €4.98b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €8.04b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of €12.07. Compared to the current share price of €11.71, the stock is about right, perhaps slightly undervalued at a 3.0% discount to what it is available for right now.
The assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Schaeffler as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 12.4%, which is based on a levered beta of 1.251. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
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. For SHA, there are three key factors you should look at:
- Financial Health: Does SHA have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does SHA’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: Are there other high quality stocks you could be holding instead of SHA? 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 does a DCF calculation for every DE stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.