A Look At The Fair Value Of Sonae, SGPS, S.A. (ELI:SON)

By
Simply Wall St
Published
June 19, 2021
ENXTLS:SON
Source: Shutterstock

How far off is Sonae, SGPS, S.A. (ELI:SON) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Sonae SGPS

Crunching the numbers

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (€, Millions) €450.0m €121.0m €168.0m €137.0m €119.8m €109.8m €104.0m €100.6m €98.8m €98.1m
Growth Rate Estimate Source Analyst x1 Analyst x2 Analyst x1 Analyst x1 Est @ -12.57% Est @ -8.31% Est @ -5.32% Est @ -3.23% Est @ -1.77% Est @ -0.75%
Present Value (€, Millions) Discounted @ 11% €407 €98.8 €124 €91.4 €72.2 €59.9 €51.2 €44.8 €39.8 €35.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €1.0b

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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = €98m× (1 + 1.6%) ÷ (11%– 1.6%) = €1.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €1.1b÷ ( 1 + 11%)10= €403m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €1.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of €0.8, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
ENXTLS:SON Discounted Cash Flow June 20th 2021

The 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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Sonae SGPS 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 11%, which is based on a levered beta of 1.314. 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:

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. 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Sonae SGPS, we've put together three additional aspects you should further research:

  1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Sonae SGPS (including 1 which is significant) .
  2. Future Earnings: How does SON'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 ENXTLS every day. If you want to find the calculation for other stocks just search here.

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