Estimating The Fair Value Of Lyko Group AB (publ) (STO:LYKO A)

Key Insights

• Lyko Group's estimated fair value is kr187 based on 2 Stage Free Cash Flow to Equity
• Current share price of kr172 suggests Lyko Group is trading close to its fair value
• Analyst price target for LYKO A is kr151 which is 19% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Lyko Group AB (publ) (STO:LYKO A) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Lyko Group

Crunching The Numbers

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. 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, 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 (SEK, Millions)	kr99.7m	kr123.0m	kr139.7m	kr153.2m	kr163.7m	kr171.8m	kr178.0m	kr182.6m	kr186.2m	kr189.0m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 13.60%	Est @ 9.64%	Est @ 6.87%	Est @ 4.93%	Est @ 3.58%	Est @ 2.63%	Est @ 1.96%	Est @ 1.50%
Present Value (SEK, Millions) Discounted @ 6.3%	kr93.7	kr109	kr116	kr120	kr121	kr119	kr116	kr112	kr107	kr102

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr1.1b

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 6.3%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = kr189m× (1 + 0.4%) ÷ (6.3%– 0.4%) = kr3.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= kr3.2b÷ ( 1 + 6.3%)¹⁰= kr1.7b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is kr2.9b. 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 about fair value at a 7.7% 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.

Important Assumptions

Now 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 Lyko 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 6.3%, which is based on a levered beta of 1.060. 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 Lyko Group

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. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. For Lyko Group, we've put together three relevant items you should further research:

1. Risks: We feel that you should assess the 3 warning signs for Lyko Group we've flagged before making an investment in the company.
2. Future Earnings: How does LYKO A'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the OM 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.