Today we will run through one way of estimating the intrinsic value of Serneke Group AB (publ) (STO:SRNKE B) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
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.
What's the estimated valuation?
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.
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) forecast
|Levered FCF (SEK, Millions)||-kr140.5m||kr32.0m||kr56.3m||kr86.3m||kr118.6m||kr149.8m||kr177.6m||kr200.9m||kr219.5m||kr234.0m|
|Growth Rate Estimate Source||Analyst x2||Analyst x2||Est @ 75.96%||Est @ 53.29%||Est @ 37.42%||Est @ 26.31%||Est @ 18.54%||Est @ 13.09%||Est @ 9.28%||Est @ 6.61%|
|Present Value (SEK, Millions) Discounted @ 9.2%||-kr129||kr26.8||kr43.2||kr60.6||kr76.3||kr88.2||kr95.7||kr99.1||kr99.1||kr96.7|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr557m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 0.4%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = kr234m× (1 + 0.4%) ÷ (9.2%– 0.4%) = kr2.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= kr2.7b÷ ( 1 + 9.2%)10= kr1.1b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is kr1.7b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of kr60.9, the company appears about fair value at a 9.0% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
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. 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 Serneke 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 9.2%, which is based on a levered beta of 1.691. 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.
Although the valuation of a company is important, it is only one of many factors that you need to assess 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 Serneke Group, we've put together three additional aspects you should assess:
- Risks: Take risks, for example - Serneke Group has 3 warning signs (and 1 which is potentially serious) we think you should know about.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SRNKE B's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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 Swedish stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. 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.
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