- Energy Services
Calculating The Fair Value Of Vallourec S.A. (EPA:VK)
- The projected fair value for Vallourec is €11.11 based on 2 Stage Free Cash Flow to Equity
- With €11.56 share price, Vallourec appears to be trading close to its estimated fair value
- Analyst price target for VK is €19.62, which is 77% above our fair value estimate
Does the March share price for Vallourec S.A. (EPA:VK) 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. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for Vallourec
Is Vallourec Fairly Valued?
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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
|Levered FCF (€, Millions)||€264.4m||€499.5m||€633.6m||€453.0m||€356.7m||€304.1m||€273.3m||€254.3m||€242.3m||€234.7m|
|Growth Rate Estimate Source||Analyst x4||Analyst x4||Analyst x2||Analyst x1||Est @ -21.26%||Est @ -14.73%||Est @ -10.15%||Est @ -6.95%||Est @ -4.71%||Est @ -3.14%|
|Present Value (€, Millions) Discounted @ 13%||€234||€390||€437||€276||€192||€145||€115||€94.5||€79.6||€68.1|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €2.0b
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. 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 (0.5%) 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 13%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = €235m× (1 + 0.5%) ÷ (13%– 0.5%) = €1.9b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €1.9b÷ ( 1 + 13%)10= €542m
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 €2.6b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €11.6, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Vallourec 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 13%, which is based on a levered beta of 1.862. 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 Vallourec
- Debt is well covered by earnings.
- No major weaknesses identified for VK.
- Expected to breakeven next year.
- Good value based on P/S ratio compared to estimated Fair P/S ratio.
- Debt is not well covered by operating cash flow.
- Has less than 3 years of cash runway based on current free cash flow.
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. The DCF model is not a perfect stock valuation tool. 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. For Vallourec, there are three pertinent elements you should assess:
- Risks: Take risks, for example - Vallourec has 1 warning sign we think you should be aware of.
- Future Earnings: How does VK'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 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 French stock every day, so if you want to find the intrinsic value of any other stock just search here.
Valuation is complex, but we're helping make it simple.
Find out whether Vallourec is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.
Vallourec S.A., through its subsidiaries, provides tubular solutions for the oil and gas, industry, and energy markets in Europe, North America, South America, Asia, the Middle East, and internationally.
Good value with adequate balance sheet.