What is the distance between Savencia SA (EPA:SAVE) and its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by projecting its future cash flows and then discounting them to the present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!

We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.

Discover our latest analysis for Savencia

crush numbers

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later years.

Generally, 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 present value:

Estimated free cash flow (FCF) over 10 years

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = €380 million

The second stage is also known as the 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 10-year government bond yield of 0.3%. We discount terminal cash flows to present value at a cost of equity of 5.5%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = €39m × (1 + 0.3%) ÷ (5.5%– 0.3%) = €752m

Present value of terminal value (PVTV)= TV / (1 + r)^ten= €752m÷ ( 1 + 5.5%)^ten= €440m

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 820 million euros. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of €66.4, the company appears around fair value at the time of writing. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.

Important assumptions

Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. 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 complete picture of a company’s potential performance. Since we consider Savencia as a potential shareholder, 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 5.5%, which is based on a leveraged beta of 1.075. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Look forward:

While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. DCF models are not the be-all and end-all of investment valuation. 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 the valuation. For Savencia, we have compiled three important factors for you to consider:

1. Risks: Be aware that Savencia displays 1 warning sign in our investment analysis , you should know…
2. Future earnings: How does SAVE’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

PS. Simply Wall St updates its DCF calculation for every French stock daily, 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. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.