Stock Analysis

A Look At The Fair Value Of Universal Music Group N.V. (AMS:UMG)

ENXTAM:UMG
Source: Shutterstock

Key Insights

  • Universal Music Group's estimated fair value is €27.64 based on 2 Stage Free Cash Flow to Equity
  • Universal Music Group's €27.49 share price indicates it is trading at similar levels as its fair value estimate
  • The €30.53 analyst price target for UMG is 10% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Universal Music Group N.V. (AMS:UMG) by projecting its future cash flows and then discounting them to today's value. This will be done using 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Universal Music Group

What's The Estimated Valuation?

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (€, Millions) €1.75b €1.99b €2.11b €2.33b €2.48b €2.61b €2.70b €2.78b €2.84b €2.90b
Growth Rate Estimate Source Analyst x9 Analyst x8 Analyst x2 Analyst x2 Est @ 6.64% Est @ 4.92% Est @ 3.70% Est @ 2.86% Est @ 2.26% Est @ 1.85%
Present Value (€, Millions) Discounted @ 5.9% €1.6k €1.8k €1.8k €1.9k €1.9k €1.8k €1.8k €1.8k €1.7k €1.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €18b

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 0.9%. We discount the terminal cash flows to today's value at a cost of equity of 5.9%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = €2.9b× (1 + 0.9%) ÷ (5.9%– 0.9%) = €58b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €58b÷ ( 1 + 5.9%)10= €33b

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 €51b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of €27.5, the company appears about fair value at a 0.6% 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.

dcf
ENXTAM:UMG Discounted Cash Flow July 18th 2024

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 Universal Music 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 5.9%, which is based on a levered beta of 1.089. 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 Universal Music Group

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Entertainment market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Current share price is below our estimate of fair value.
Threat
  • Annual earnings are forecast to grow slower than the Dutch market.

Moving On:

Although the valuation of a company is important, 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Universal Music Group, we've put together three further items you should further research:

  1. Risks: For example, we've discovered 1 warning sign for Universal Music Group that you should be aware of before investing here.
  2. Future Earnings: How does UMG'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 ENXTAM 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.