Cogelec SA (EPA:ALLEC) Shares Could Be 46% Below Their Intrinsic Value Estimate

By
Simply Wall St
Published
May 24, 2021
ENXTPA:ALLEC
Source: Shutterstock

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

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Cogelec

Crunching the numbers

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (€, Millions) €1.00m €4.40m €5.40m €6.12m €6.69m €7.14m €7.48m €7.74m €7.93m €8.08m
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Est @ 13.26% Est @ 9.39% Est @ 6.68% Est @ 4.78% Est @ 3.46% Est @ 2.53% Est @ 1.88%
Present Value (€, Millions) Discounted @ 5.5% €0.9 €4.0 €4.6 €4.9 €5.1 €5.2 €5.1 €5.0 €4.9 €4.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €44m

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 (0.4%) 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 5.5%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = €8.1m× (1 + 0.4%) ÷ (5.5%– 0.4%) = €158m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €158m÷ ( 1 + 5.5%)10= €92m

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 €136m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of €8.7, the company appears quite good value at a 46% 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:ALLEC Discounted Cash Flow May 25th 2021

Important assumptions

Now 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 Cogelec 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 0.990. 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.

Looking Ahead:

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. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Cogelec, there are three further factors you should further research:

  1. Risks: Every company has them, and we've spotted 1 warning sign for Cogelec you should know about.
  2. Future Earnings: How does ALLEC'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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