Does This Valuation Of AAK AB (publ.) (STO:AAK) Imply Investors Are Overpaying?
- AAK AB (publ.)'s estimated fair value is kr136 based on 2 Stage Free Cash Flow to Equity
- Current share price of kr172 suggests AAK AB (publ.) is potentially 26% overvalued
- The kr199 analyst price target for AAK is 46% more than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of AAK AB (publ.) (STO:AAK) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.
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.
View our latest analysis for AAK AB (publ.)
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 start off with, we need to estimate 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) estimate
|Levered FCF (SEK, Millions)||kr3.52b||kr2.38b||kr2.06b||kr1.87b||kr1.75b||kr1.67b||kr1.63b||kr1.60b||kr1.58b||kr1.57b|
|Growth Rate Estimate Source||Analyst x5||Analyst x5||Analyst x4||Est @ -9.24%||Est @ -6.32%||Est @ -4.27%||Est @ -2.84%||Est @ -1.84%||Est @ -1.14%||Est @ -0.65%|
|Present Value (SEK, Millions) Discounted @ 5.3%||kr3.3k||kr2.1k||kr1.8k||kr1.5k||kr1.4k||kr1.2k||kr1.1k||kr1.1k||kr996||kr940|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr15b
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 0.5%. We discount the terminal cash flows to today's value at a cost of equity of 5.3%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = kr1.6b× (1 + 0.5%) ÷ (5.3%– 0.5%) = kr33b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= kr33b÷ ( 1 + 5.3%)10= kr20b
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 kr35b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of kr172, the company appears slightly overvalued at the time of writing. 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.
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 AAK AB (publ.) 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 5.3%, 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 AAK AB (publ.)
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Dividend is low compared to the top 25% of dividend payers in the Food market.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow for the next 3 years.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company has no free cash flows.
- Annual earnings are forecast to grow slower than the Swedish market.
Although the valuation of a company is important, it 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. 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 exceeding the intrinsic value? For AAK AB (publ.), there are three relevant factors you should further research:
- Financial Health: Does AAK have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does AAK'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.
- 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 Swedish 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 AAK AB (publ.) 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
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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.
AAK AB (publ.)
AAK AB (publ.) develops and sells plant-based oils and fats worldwide.
Proven track record with adequate balance sheet.