Estimating The Intrinsic Value Of Safran SA (EPA:SAF)

Key Insights

• The projected fair value for Safran is €184 based on 2 Stage Free Cash Flow to Equity
• Current share price of €163 suggests Safran is potentially trading close to its fair value
• The €176 analyst price target for SAF is 4.7% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Safran SA (EPA:SAF) 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. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Safran

What's The Estimated Valuation?

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 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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (€, Millions)	€2.84b	€3.26b	€3.61b	€3.69b	€3.75b	€3.81b	€3.85b	€3.90b	€3.94b	€3.98b
Growth Rate Estimate Source	Analyst x9	Analyst x9	Analyst x3	Analyst x1	Est @ 1.68%	Est @ 1.44%	Est @ 1.26%	Est @ 1.14%	Est @ 1.06%	Est @ 1.00%
Present Value (€, Millions) Discounted @ 5.5%	€2.7k	€2.9k	€3.1k	€3.0k	€2.9k	€2.8k	€2.6k	€2.5k	€2.4k	€2.3k

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

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 0.9%. We discount the terminal cash flows to today's value at a cost of equity of 5.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = €4.0b× (1 + 0.9%) ÷ (5.5%– 0.9%) = €86b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €86b÷ ( 1 + 5.5%)¹⁰= €50b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is €77b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of €163, the company appears about fair value at a 11% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

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. 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 Safran 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 5.5%, which is based on a levered beta of 0.812. 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 Safran

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 Safran, there are three pertinent items you should explore:

1. Financial Health: Does SAF 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.
2. Future Earnings: How does SAF'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 ENXTPA 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.