Akzo Nobel NV (AMS: AKZA) shares could be 26% lower than their intrinsic value estimate
Today we’re going to go over one way to estimate the intrinsic value of Akzo Nobel NV (AMS: AKZA) by projecting its future cash flows, then discounting them to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
Discover our latest analysis for Akzo Nobel
Is Akzo Nobel valued enough?
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year free cash flow (FCF) forecast
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Leverage FCF (€, Millions) | € 831.9m | € 973.7 M | 1.07 billion euros | 1.16 billion euros | 1.25 billion euros | 1.31 billion euros | 1.35 billion euros | 1.38 billion euros | € 1.40 billion | € 1.42 billion |
Source of estimated growth rate | Analyst x11 | Analyst x11 | Analyst x8 | Analyst x3 | Analyst x2 | Is 4.57% | East @ 3.24% | Is 2.3% | Is @ 1.65% | Is @ 1.2% |
Present value (€, Millions) discounted at 5.0% | € 792 | € 883 | € 923 | € 957 | € 978 | € 974 | € 957 | € 932 | € 902 | € 869 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = € 9.2bn
It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this ten-year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.1%. We discount the terminal cash flows to their present value at a cost of equity of 5.0%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = € 1.4 billion × (1 + 0.1%) ÷ (5.0% – 0.1%) = € 29 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= € 29bn ÷ (1 + 5.0%)^{ten}= € 18bn
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the Total Equity Value, which in this case is 27 billion euros. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current price of 106 €, the company appears to be slightly undervalued with a discount of 26% compared to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The hypotheses
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we consider Akzo Nobel 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 takes debt into account. In this calculation, we used 5.0%, which is based on a leveraged beta of 1.037. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed 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’s just one of the many factors you need to evaluate for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. What is the reason why the stock price is below intrinsic value? For Akzo Nobel, you need to assess three additional aspects:
- Risks: You should be aware of the 2 warning signs for Akzo Nobel we found out before considering an investment in the business.
- Future benefits: How does AKZA’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading 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.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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