The intrinsic value of Evonik Industries AG (ETR: EVK) is potentially 87% higher over its share price
In this article, we will estimate the intrinsic value of Evonik Industries AG (ETR: EVK) by estimating the company’s future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it’s not too hard to follow, as you will see in our example!
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
See our latest review for Evonik Industries
The method
We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we need to estimate the next ten years of cash flow. 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 down during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, 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
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF (€, million) | € 838.7 million | 962.1 million euros | 1.07 billion euros | € 1.23 billion | € 1.30bn | € 1.34bn | € 1.37bn | € 1.39bn | € 1.41bn | € 1.42 billion |
Source of estimated growth rate | Analyst x5 | Analyst x9 | Analyst x8 | Analyst x2 | Analyst x2 | Is 3.35% | Is 2.34% | Is 1.64% | Is 1.15% | Is 0.81% |
Present value (€, million) discounted at 5.2% | € 797 | € 869 | € 918 | € 1.0K | € 1.0K | € 988 | € 961 | € 929 | € 893 | € 856 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 9.2 billion euros
The second stage is also known as terminal value, it is the cash flow of the business after the first stage. 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 0.01%. We discount the terminal cash flows to their present value at a cost of equity of 5.2%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = € 1.4 billion × (1 + 0.01%) ÷ (5.2% – 0.01%) = € 27 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= € 27bn ÷ (1 + 5.2%)^{ten}= € 16 billion
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 value of equity, which in this case is 26 billion euros. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of € 29.6, the company looks quite good value at a discount of 46% from the current share price. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
The hypotheses
Now the most important data for a discounted cash flow is the discount rate and, of course, the actual 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 complete picture of a company’s potential performance. Since we view Evonik Industries 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 5.2%, which is based on a leveraged beta of 1.099. 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.
Next steps:
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. DCF models are not the alpha and omega of investment valuation. Preferably, you would apply different cases and assumptions and see how they would impact 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. Why is intrinsic value greater than the current share price? For Evonik Industries, we have compiled three essential aspects that you should take a closer look at:
- Risks: For example, we discovered 1 warning sign for Evonik Industries which you should be aware of before investing here.
- Future income: How does EVK’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. Simply Wall St updates its DCF calculation for every German 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 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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