AB SKF fair value estimate (publ) (STO: SKF B)
How far is AB SKF (publ) (STO: SKF B) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair 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. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.
We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. If you would like to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
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The calculation
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 have 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.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-year Free Cash Flow (FCF) estimate
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF (SEK, Millions) | 6.40 kr | kr7.02b | 6.28 kr | kr6.52b | kr6.50b | kr6.50b | kr6.50b | kr6.51b | kr6.52b | kr6.53b |
Source of growth rate estimate | Analyst x12 | Analyst x10 | Analyst x1 | Analyst x1 | East @ -0.3% | East @ -0.11% | Is 0.02% | Est @ 0.11% | Est @ 0.18% | Est @ 0.22% |
Present value (SEK, million) discounted at 5.7% | kr6.1k | kr6.3k | kr5.3k | 5.2 kr | 4.9k kr | kr4.7k | kr4.4k | kr4.2k | kr4.0k | kr3.7k |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = kr49b
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 5.7%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = kr6.5b × (1 + 0.3%) ÷ (5.7% – 0.3%) = kr122b
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= kr122b ÷ (1 + 5.7%)^{ten}= kr70b
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is kr118b. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 223 kroner, the company appears to be roughly at fair value with a 14% discount to the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
Now the most important inputs to a discounted cash flow are 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 full picture of a company’s potential performance. Since we consider AB SKF 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 5.7%, which is based on a leveraged beta of 1.142. 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 from globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a business. The DCF model is not a perfect equity valuation tool. 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, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For AB SKF, we have put together three essential elements to consider:
- Risks: For example, we have identified 1 warning sign for AB SKF that you need to be aware of.
- Future benefits: How does SKF B’s growth rate compare to 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. 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.
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This Simply Wall St article is general in nature. 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 material. Simply Wall St has no position in the mentioned stocks.
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