Vestas Wind Systems A/S' (CPH:VWS) Intrinsic Value Is Potentially 20% Below Its Share Price

By
Simply Wall St
Published
September 15, 2020
CPSE:VWS
Source: Shutterstock

Today we will run through one way of estimating the intrinsic value of Vestas Wind Systems A/S (CPH:VWS) 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 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.

See our latest analysis for Vestas Wind Systems

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. To start off with, we need to estimate 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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (€, Millions) €759.0m €855.9m €980.5m €1.18b €1.31b €1.40b €1.48b €1.53b €1.58b €1.61b
Growth Rate Estimate Source Analyst x13 Analyst x11 Analyst x2 Analyst x1 Est @ 10.45% Est @ 7.42% Est @ 5.29% Est @ 3.81% Est @ 2.77% Est @ 2.04%
Present Value (€, Millions) Discounted @ 7.3% €708 €744 €794 €893 €920 €921 €904 €874 €838 €797

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €8.4b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 0.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = €1.6b× (1 + 0.3%) ÷ (7.3%– 0.3%) = €23b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €23b÷ ( 1 + 7.3%)10= €12b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €20b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of kr.950, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
CPSE:VWS Discounted Cash Flow September 16th 2020

Important 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 these inputs, I recommend redoing the calculations yourself and playing with them. 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 Vestas Wind Systems 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 7.3%, which is based on a levered beta of 1.155. 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:

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. 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. Can we work out why the company is trading at a premium to intrinsic value? For Vestas Wind Systems, there are three important elements you should further examine:

  1. Risks: For instance, we've identified 2 warning signs for Vestas Wind Systems (1 is significant) you should be aware of.
  2. Future Earnings: How does VWS'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. Simply Wall St updates its DCF calculation for every Danish stock every day, so if you want to find the intrinsic value of any other stock just search here.

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