A Look At The Fair Value Of Demant A/S (CPH:DEMANT)

Key Insights

• Demant's estimated fair value is kr.339 based on 2 Stage Free Cash Flow to Equity
• Demant's kr.280 share price indicates it is trading at similar levels as its fair value estimate
• The kr.256 analyst price target for DEMANT is 25% less than our estimate of fair value

How far off is Demant A/S (CPH:DEMANT) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 Demant

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. 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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (DKK, Millions)	kr.2.16b	kr.2.78b	kr.3.14b	kr.3.34b	kr.4.01b	kr.4.34b	kr.4.60b	kr.4.80b	kr.4.95b	kr.5.06b
Growth Rate Estimate Source	Analyst x7	Analyst x8	Analyst x8	Analyst x3	Analyst x2	Est @ 8.33%	Est @ 5.95%	Est @ 4.29%	Est @ 3.13%	Est @ 2.31%
Present Value (DKK, Millions) Discounted @ 6.3%	kr.2.0k	kr.2.5k	kr.2.6k	kr.2.6k	kr.2.9k	kr.3.0k	kr.3.0k	kr.2.9k	kr.2.8k	kr.2.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr.27b

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 0.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.3%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = kr.5.1b× (1 + 0.4%) ÷ (6.3%– 0.4%) = kr.86b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= kr.86b÷ ( 1 + 6.3%)¹⁰= kr.46b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is kr.73b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of kr.280, the company appears about fair value at a 17% 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.

Important 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. 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 Demant 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 6.3%, which is based on a levered beta of 0.999. 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 Demant

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. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Demant, we've put together three essential elements you should explore:

1. Risks: Every company has them, and we've spotted 1 warning sign for Demant you should know about.
2. Future Earnings: How does DEMANT'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 CPSE every day. If you want to find the calculation for other stocks just search here.

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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.