Estimating The Fair Value Of Alfa, S. A. B. de C. V. (BMV:ALFAA)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Alfa, S. A. B. de C. V. (BMV:ALFAA) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Alfa S. A. B. de C. V

Is Alfa S. A. B. de C. V 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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (MX$, Millions)	Mex$10.3b	Mex$9.82b	Mex$9.71b	Mex$9.86b	Mex$10.2b	Mex$10.6b	Mex$11.2b	Mex$11.8b	Mex$12.6b	Mex$13.4b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -1.03%	Est @ 1.45%	Est @ 3.19%	Est @ 4.4%	Est @ 5.25%	Est @ 5.85%	Est @ 6.27%	Est @ 6.56%
Present Value (MX$, Millions) Discounted @ 16%	Mex$8.9k	Mex$7.3k	Mex$6.2k	Mex$5.4k	Mex$4.8k	Mex$4.3k	Mex$3.9k	Mex$3.5k	Mex$3.2k	Mex$3.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = Mex$50b

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 7.2%. We discount the terminal cash flows to today's value at a cost of equity of 16%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = Mex$13b× (1 + 7.2%) ÷ (16%– 7.2%) = Mex$159b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= Mex$159b÷ ( 1 + 16%)¹⁰= Mex$35b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is Mex$86b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of Mex$14.4, the company appears about fair value at a 19% 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.

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Alfa S. A. B. de C. V 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 16%, which is based on a levered beta of 1.549. 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 ideally won't be the sole piece of analysis you scrutinize for 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 Alfa S. A. B. de C. V, we've put together three relevant factors you should look at:

1. Risks: Every company has them, and we've spotted 2 warning signs for Alfa S. A. B. de C. V you should know about.
2. Future Earnings: How does ALFA A'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 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the BMV every day. If you want to find the calculation for other stocks 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.