Is H & M Hennes & Mauritz AB (publ) (STO:HM B) trading at a 46% discount?
Today we are going to do a simple overview of a valuation method used to estimate the attractiveness of H&M Hennes & Mauritz AB (publ) (STO: HM B) as a business opportunity. investment by projecting its future cash flows and then discounting them to today’s 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!
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
Check out our latest analysis for H&M Hennes & Mauritz
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To start, we need to estimate the cash flows 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.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF (SEK, millions)||kr19.5b||kr22.4b||kr23.1b||kr19.1b||kr19.0b||kr19.0b||kr19.1b||kr19.1b||kr19.2b||kr19.2b|
|Growth rate estimate Source||Analyst x13||Analyst x11||Analyst x2||Analyst x1||Is @ -0.12%||Is 0.02%||Is at 0.12%||Is at 0.19%||Is at 0.24%||Is at 0.28%|
|Present value (SEK, million) discounted at 5.2%||kr18.6k||kr20.2k||kr19.8k||kr15.6k||kr14.8k||kr14.0k||13,400 kr||kr12.7k||kr12.1k||11,500 kr|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = kr153b
We now need to calculate the terminal value, which represents 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 0.4%. We discount terminal cash flows to present value at a cost of equity of 5.2%.
Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = kr19b × (1 + 0.4%) ÷ (5.2%– 0.4%) = kr397b
Present value of terminal value (PVTV)= TV / (1 + r)ten= kr397b÷ ( 1 + 5.2%)ten= kr238b
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 391 billion kr. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of 128 kr, the company seems to have quite good value with a discount of 46% from the current share price. 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.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend you redo the calculations yourself and play around with them. 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 H&M Hennes & Mauritz 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 into account the debt. In this calculation, we used 5.2%, which is based on a leveraged beta of 1.147. 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.
Let’s move on :
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is the stock price below intrinsic value? For H&M Hennes & Mauritz, we’ve compiled three more factors you should explore:
- Risks: Every business has them, and we’ve spotted 1 warning sign for H&M Hennes & Mauritz you should know.
- Future earnings: How does HM B’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.
- 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. The Simply Wall St app performs an updated cash flow valuation for every stock on OM every day. If you want to find the calculation for other stocks, 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.