Calculating The Intrinsic Value Of Vetoquinol SA (EPA:VETO)

By
Simply Wall St
Published
December 21, 2021
ENXTPA:VETO
Source: Shutterstock

Today we will run through one way of estimating the intrinsic value of Vetoquinol SA (EPA:VETO) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Vetoquinol

The method

We're 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 a stable growth rate. 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.

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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (€, Millions) €66.6m €65.8m €65.4m €65.1m €65.0m €65.0m €65.1m €65.2m €65.4m €65.5m
Growth Rate Estimate Source Analyst x3 Analyst x3 Est @ -0.68% Est @ -0.37% Est @ -0.16% Est @ -0.01% Est @ 0.1% Est @ 0.17% Est @ 0.22% Est @ 0.26%
Present Value (€, Millions) Discounted @ 4.2% €64.0 €60.7 €57.8 €55.3 €53.0 €50.9 €48.9 €47.0 €45.2 €43.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €526m

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 0.3%. We discount the terminal cash flows to today's value at a cost of equity of 4.2%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = €66m× (1 + 0.3%) ÷ (4.2%– 0.3%) = €1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €1.7b÷ ( 1 + 4.2%)10= €1.1b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €1.7b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of €127, the company appears about fair value at a 9.4% 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.

dcf
ENXTPA:VETO Discounted Cash Flow December 21st 2021

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 Vetoquinol 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 4.2%, which is based on a levered beta of 0.800. 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.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 Vetoquinol, we've put together three relevant aspects you should explore:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Vetoquinol , and understanding this should be part of your investment process.
  2. Future Earnings: How does VETO'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 French stock every day, so if you want to find the intrinsic value of any other stock just search here.

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