Do investors undervalue La Française de l’Energie SA (EPA: LFDE) by 25%?
In this article, we will estimate the intrinsic value of La Française de l’Energie SA (EPA: LFDE) by projecting its future cash flows and then discounting them to the present value. The DCF (Discounted Cash Flow) model is the tool we will apply to do this. Don’t be put off by the lingo, the math is actually pretty straightforward.
We generally believe that the value of a business is 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. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
See our latest analysis for La Française de l’Energie
We use what is called a 2-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 the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) forecast
|Levered FCF (€, million)||– € 7.46m||– € 11.9 million||6.85 million euros||€ 8.90m||€ 10.8m||€ 12.4m||€ 13.7m||€ 14.7m||€ 15.5m||€ 16.1m|
|Source of estimated growth rate||Analyst x3||Analyst x3||Analyst x3||Is 30%||Est @ 21.11%||Is 14.88%||Is 10.53%||Is 7.48%||Is 5.34%||Is 3.85%|
|Present value (€, million) discounted at 7.2%||– € 7.0||– € 10.3||€ 5.6||€ 6.7||€ 7.6||€ 8.1||€ 8.4||€ 8.4||€ 8.3||€ 8.0|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 43 M €
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 used the 5-year average of the 10-year government bond yield (0.4%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 7.2%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = € 16 million × (1 + 0.4%) ÷ (7.2% – 0.4%) = € 235 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= € 235m ÷ (1 + 7.2%)ten= 117 M €
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which translates into the Total Equity Value, which in this case is € 160m. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current price of 23.2 €, the company appears a little undervalued with a discount of 25% 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.
We draw your attention to the fact that the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. 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 complete picture of a company’s potential performance. Since we consider La Française de l’Energie to be 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 into account the debt. In this calculation, we used 7.2%, which is based on a leveraged beta of 1.324. 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 of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
While a business valuation is important, ideally it won’t be the only analysis you review for a business. The DCF model is not a perfect inventory valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Can we understand why the company trades at a discount to its intrinsic value? For La Française de l’Energie, we have gathered three relevant elements to take into account:
- Risks: Take, for example, the ubiquitous spectrum of investment risk. We have identified 2 warning signs with La Française de l’Energie (at least 1 which is a bit unpleasant), and understanding them should be part of your investment process.
- Future income: How does LFDE’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality inventory to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each stock in the ENXTPA. If you want to find the calculation for other actions, 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 any stock, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in any of the stocks mentioned.
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