Stock Analysis
An Intrinsic Calculation For Capgemini SE (EPA:CAP) Suggests It's 38% Undervalued
Key Insights
- Capgemini's estimated fair value is €310 based on 2 Stage Free Cash Flow to Equity
- Capgemini's €193 share price signals that it might be 38% undervalued
- The €229 analyst price target for CAP is 26% less than our estimate of fair value
Today we will run through one way of estimating the intrinsic value of Capgemini SE (EPA:CAP) 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!
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.
Check out our latest analysis for Capgemini
The Model
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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (€, Millions) | €2.13b | €2.38b | €2.67b | €3.03b | €3.29b | €3.49b | €3.65b | €3.79b | €3.89b | €3.98b |
Growth Rate Estimate Source | Analyst x5 | Analyst x4 | Analyst x1 | Analyst x1 | Est @ 8.46% | Est @ 6.25% | Est @ 4.70% | Est @ 3.61% | Est @ 2.85% | Est @ 2.32% |
Present Value (€, Millions) Discounted @ 7.3% | €2.0k | €2.1k | €2.2k | €2.3k | €2.3k | €2.3k | €2.2k | €2.1k | €2.1k | €2.0k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €21b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.1%) 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 7.3%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = €4.0b× (1 + 1.1%) ÷ (7.3%– 1.1%) = €64b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €64b÷ ( 1 + 7.3%)10= €32b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €53b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €193, the company appears quite undervalued at a 38% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
The 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 Capgemini 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 1.177. 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 Capgemini
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Earnings growth over the past year is below its 5-year average.
- Dividend is low compared to the top 25% of dividend payers in the IT market.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow slower than the French market.
Looking Ahead:
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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Capgemini, we've compiled three relevant factors you should consider:
- Financial Health: Does CAP 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.
- Future Earnings: How does CAP'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 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. 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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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
About ENXTPA:CAP
Capgemini
Engages in the provision of consulting, digital transformation, technology, and engineering services primarily in North America, France, the United Kingdom, Ireland, the rest of Europe, the Asia-Pacific, and Latin America.