Stock Analysis

Are Koninklijke DSM N.V. (AMS:DSM) Investors Paying Above The Intrinsic Value?

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ENXTAM:DSM
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How far off is Koninklijke DSM N.V. (AMS:DSM) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

See our latest analysis for Koninklijke DSM

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.

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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (€, Millions) €885.3m €1.01b €1.10b €1.15b €1.19b €1.22b €1.24b €1.25b €1.26b €1.27b
Growth Rate Estimate Source Analyst x13 Analyst x11 Analyst x2 Analyst x2 Est @ 3.26% Est @ 2.31% Est @ 1.65% Est @ 1.18% Est @ 0.85% Est @ 0.62%
Present Value (€, Millions) Discounted @ 4.5% €847 €928 €961 €966 €955 €935 €909 €880 €849 €818

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €9.0b

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 0.09%. We discount the terminal cash flows to today's value at a cost of equity of 4.5%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = €1.3b× (1 + 0.09%) ÷ (4.5%– 0.09%) = €29b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €29b÷ ( 1 + 4.5%)10= €19b

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 €28b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of €194, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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ENXTAM:DSM Discounted Cash Flow November 24th 2021

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 Koninklijke DSM 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 4.5%, which is based on a levered beta of 1.010. 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:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price exceeding the intrinsic value? For Koninklijke DSM, we've compiled three essential items you should explore:

  1. Risks: Be aware that Koninklijke DSM is showing 1 warning sign in our investment analysis , you should know about...
  2. Future Earnings: How does DSM'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. Simply Wall St updates its DCF calculation for every Dutch stock every day, so if you want to find the intrinsic value of any other stock just search here.

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