Is there an opportunity with the 28% undervaluation of SSAB AB (publ) (STO: SSAB A)?
Today we’re going to walk through one way to estimate the intrinsic value of SSAB AB (publ) (STO: SSAB A) 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. There really isn’t much to it, although it might seem quite complex.
There are many ways that businesses can be valued, so we would like to stress that a DCF is not perfect for all situations. Anyone who wants to know a little more about intrinsic value should have read the Simply Wall St analysis model.
See our latest analysis for SSAB
Crunch the numbers
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 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.
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) forecast
|Leverage FCF (SEK, Millions)||4.39 billion kr||4.78 billion kr||3.64 billion kr||kr3.62b||kr3.61b||kr3.61b||3.61 billion kr||3.61 billion kr||3.62 billion kr||kr3.63b|
|Source of estimated growth rate||Analyst x9||Analyst x9||Analyst x6||East @ -0.52%||East @ -0.27%||East @ -0.09%||Is 0.04%||Is 0.13%||Is 0.19%||Is 0.23%|
|Present value (SEK, million) discounted at 6.2%||kr4.1k||kr4.2k||kr3.0k||kr2.8k||2.7 kr||kr2.5k||kr2.4k||2.2 kr||kr2.1k||kr2.0k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = kr28b
Now we need to calculate the terminal value, which takes into account all future cash flows after that 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 6.2%.
Terminal value (TV)= FCF2030 Ã (1 + g) Ã· (r – g) = kr3.6b Ã (1 + 0.3%) Ã· (6.2% – 0.3%) = kr62b
Present value of terminal value (PVTV)= TV / (1 + r)ten= kr62b Ã· (1 + 6.2%)ten= kr34b
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 62 billion kr. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of 43.6 kr, the company appears to be a bit undervalued at a 28% discount from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
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. 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 SSAB 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 6.2%, which is based on a leveraged beta of 1.237. 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.
Valuation is only one side of the coin in terms of building your investment thesis, and ideally, it won’t be the only piece of analysis you will look at for a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. What is the reason why the stock price is lower than intrinsic value? For SSAB, we’ve compiled three basic things you should research further:
- Risks: Concrete example, we have spotted 1 warning sign for SSAB you have to be aware of it.
- Future benefits: How does SSAB A’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus number 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 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 OM share. If you want to find the calculation for other actions, do a search here.
If you decide to trade SSAB, use the cheapest platform * ranked # 1 overall by Barron’s, Interactive brokers. Trade stocks, options, futures, currencies, bonds and funds in 135 markets, all from one integrated account.
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. 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 information. Simply Wall St has no position in any of the stocks mentioned.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any comments on this article? Concerned about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.