An intrinsic calculation for ICA Gruppen AB (publ) (STO: ICA) suggests it is 45% undervalued
In this article, we will estimate the intrinsic value of ICA Gruppen AB (publ) (STO: ICA) by taking the company’s future cash flow forecast and discounting it to today’s value. Our analysis will use the discounted cash flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
See our latest review for ICA Gruppen
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. In the first step, we need to estimate the cash flow of the business over 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.
In general, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (SEK, Millions)||6.99 kr||7.39 kr||6.86 kr||kr6.52b||6.31 kr||6.17 kr||kr6.08b||kr6.02b||5.99 kr||5.97 kr|
|Source of estimated growth rate||Analyst x4||Analyst x4||Is @ -7.15%||Is @ -4.91%||Is @ -3.34%||Est @ -2.24%||Is @ -1.47%||East @ -0.93%||East @ -0.55%||East @ -0.29%|
|Present value (SEK, million) discounted at 3.8%||6.7k kr||6.9 kr kr||kr6.1k||5.6 kr||5.2 kr||4.9k kr||kr4.7k||4.5k kr||kr4.3k||kr4.1k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = kr53b
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 0.3%. We discount the terminal cash flows to their present value at a cost of equity of 3.8%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = kr6.0b × (1 + 0.3%) ÷ (3.8% – 0.3%) = kr171b
Present value of terminal value (PVTV)= TV / (1 + r)ten= kr171b ÷ (1 + 3.8%)ten= kr117b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is 170b kr. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 470 kr, the company looks quite good value with a 45% discount from 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 above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own 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 view ICA Gruppen 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 3.8%, which is based on a leverage beta of 0.800. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While valuing a business is important, it’s just one of the many factors you need to assess 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, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. What is the reason why the stock price is below intrinsic value? For ICA Gruppen, there are three important aspects that you should consider further:
- Risks: You should be aware of the 2 warning signs for ICA Gruppen (1 cannot be ignored!) We found out before considering an investment in the business.
- Future benefits: How does ICA’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 high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
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.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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 the mentioned stocks.
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