Stock Analysis

An Intrinsic Calculation For Koninklijke KPN N.V. (AMS:KPN) Suggests It's 38% Undervalued

Published
ENXTAM:KPN
Source: Shutterstock

Key Insights

  • Koninklijke KPN's estimated fair value is €5.20 based on 2 Stage Free Cash Flow to Equity
  • Koninklijke KPN's €3.22 share price signals that it might be 38% undervalued
  • Analyst price target for KPN is €3.63 which is 30% below our fair value estimate

Does the June share price for Koninklijke KPN N.V. (AMS:KPN) 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Koninklijke KPN

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (€, Millions) €912.1m €940.8m €965.3m €1.00b €1.01b €1.01b €1.02b €1.02b €1.03b €1.03b
Growth Rate Estimate Source Analyst x7 Analyst x7 Analyst x7 Analyst x2 Analyst x1 Est @ 0.54% Est @ 0.50% Est @ 0.47% Est @ 0.45% Est @ 0.44%
Present Value (€, Millions) Discounted @ 5.2% €867 €851 €830 €819 €784 €749 €716 €684 €654 €624

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €7.6b

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 5.2%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = €1.0b× (1 + 0.4%) ÷ (5.2%– 0.4%) = €22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €22b÷ ( 1 + 5.2%)10= €13b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €21b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €3.2, the company appears quite undervalued at a 38% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
ENXTAM:KPN Discounted Cash Flow June 2nd 2023

Important 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 Koninklijke KPN 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 5.2%, which is based on a levered beta of 0.800. 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 Koninklijke KPN

Strength
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Telecom market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Annual earnings are forecast to grow slower than the Dutch market.

Next Steps:

Whilst important, the DCF calculation 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. What is the reason for the share price sitting below the intrinsic value? For Koninklijke KPN, there are three pertinent factors you should assess:

  1. Risks: Take risks, for example - Koninklijke KPN has 3 warning signs we think you should be aware of.
  2. Future Earnings: How does KPN'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 Dutch stock every day, so if you want to find the intrinsic value of any other stock just search here.

Valuation is complex, but we're helping make it simple.

Find out whether Koninklijke KPN is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

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.