Is There An Opportunity With Sopra Steria Group SA's (EPA:SOP) 36% Undervaluation?
Key Insights
- The projected fair value for Sopra Steria Group is €316 based on 2 Stage Free Cash Flow to Equity
- Sopra Steria Group's €201 share price signals that it might be 36% undervalued
- Our fair value estimate is 42% higher than Sopra Steria Group's analyst price target of €223
Does the July share price for Sopra Steria Group SA (EPA:SOP) 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 today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.
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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Is Sopra Steria Group Fairly Valued?
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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | 2035 | |
Levered FCF (€, Millions) | €328.3m | €353.9m | €408.4m | €436.0m | €458.9m | €478.2m | €494.8m | €509.5m | €522.7m | €535.0m |
Growth Rate Estimate Source | Analyst x5 | Analyst x5 | Analyst x1 | Est @ 6.76% | Est @ 5.26% | Est @ 4.21% | Est @ 3.47% | Est @ 2.96% | Est @ 2.60% | Est @ 2.35% |
Present Value (€, Millions) Discounted @ 8.8% | €302 | €299 | €317 | €311 | €301 | €288 | €274 | €259 | €245 | €230 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €2.8b
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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.8%.
Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = €535m× (1 + 1.8%) ÷ (8.8%– 1.8%) = €7.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €7.7b÷ ( 1 + 8.8%)10= €3.3b
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 €6.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of €201, the company appears quite undervalued at a 36% 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.
The 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 Sopra Steria Group 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 8.8%, which is based on a levered beta of 1.373. 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.
View our latest analysis for Sopra Steria Group
SWOT Analysis for Sopra Steria Group
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- 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.
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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Sopra Steria Group, we've compiled three pertinent factors you should further research:
- Risks: To that end, you should be aware of the 1 warning sign we've spotted with Sopra Steria Group .
- Future Earnings: How does SOP'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.
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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About ENXTPA:SOP
Sopra Steria Group
Provides consulting, digital, and software development services in France and internationally.
Undervalued with solid track record and pays a dividend.
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