A look at the fair value of AVTECH Sweden AB (publ) (STO: AVT B)
Does the share price in February for AVTECH Sweden AB (publ) (STO: AVT B) reflect what it is really worth? Today we will estimate the share’s intrinsic value by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you will not be able to understand it, just read on! It is actually much less complicated than you can imagine.
Companies can be valued in many ways, so we want to point out that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should have a reading of Simply Wall St analysis model.
See our latest analysis for AVTECH Sweden
The method
We will use a two-stage DCF model, which, as the name suggests, takes into account two stages of growth. The first step is generally a higher growth period that flattens out towards the terminal value, captured in the second “steady growth period”. To begin with, we need to get estimates of the next ten years’ cash flows. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the most recent estimate or reported value. We assume that companies with shrinking free cash flow will slow down their shrinking rate, and that companies with growing 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 first years than it does in recent years.
A DCF is about the idea that a dollar in the future is worth less than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year estimate of free cash flow (FCF).
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Delivered FCF (SEK, million) | DKK 9.00 million | DKK 8.00 million | DKK 7.00 million | DKK 6.41 million | DKK 6.03 million | DKK 5.79 million | DKK 5.64 million | NOK 5.53 million | NOK 5.47 million | DKK 5.43 million |
Source for estimating growth rate | Analyst x1 | Analyst x1 | Analyst x1 | Calculated @ -8.48% | Calculated @ -5.84% | Calculated @ -3.99% | Calculated @ -2.7% | Calculated @ -1.8% | Calculated @ -1.17% | Calculated @ -0.72% |
Present value (SEK, millions) discounted @ 4.2% | 8.6 kr | 7.4 kr | 6.2 kr | 5.4 kr | 4.9 kr | 4.5 kr | 4.2 kr | 4.0 kr | 3.8 kr | 3.6 kr |
(“Estimate” = FCF Growth Rate Estimated by Simply Wall St)
The present value of 10-year cash flow (PVCF) = DKK 52 million
The second step is also known as Terminal Value, this is the business’ cash flow after 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 at current value at a cost of equity of 4.2%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = 5.4 m × (1 + 0.3%) ÷ (4.2% – 0.3%) = SEK 141 million
Present value of terminal value (PVTV)= TV / (1 + r)10= 141 m ÷ kr (1 + 4.2%)10= NOK 94 million
The total value, or share value, is then the sum of the present value of the future cash flows, which in this case is SEK 146 million. The last step is to then divide the share value by the number of outstanding shares. Compared with the current share price of SEK 2.7, the company is operating at fair value at the time of writing. Remember, however, that this is only an approximate valuation, and like all complex formulas – rubbish in, rubbish out.
The assumptions
We would like to point out that the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. If you do not agree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a complete picture of a company’s potential performance. Given that we view AVTECH Sweden 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 is responsible for the debt. In this calculation, we have used 4.2%, which is based on a leverage beta of 0.910. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry’s average beta for globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Looking ahead:
Valuation is just one side of the coin when it comes to building your investment essay, and it will preferably not be the only piece of analysis you review for a company. The DCF model is not a perfect tool for stock valuation. 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, changes in the company’s cost of equity or the risk-free interest rate can significantly affect the valuation. For AVTECH Sweden, there are three basic aspects that you should investigate further:
- Risks: All companies have them, and we’ve seen 3 warning signs for AVTECH Sweden you should know about.
- Future results: How does AVT B’s growth rate compare with its comparable companies and the wider market? Dig deeper into the analyst’s consensus figures for the coming years by interacting with our free chart for analysts’ growth expectations.
- Other high-quality alternatives: Do you like a good all-round player? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app performs a discounted cash flow valuation for each share on OM every day. If you want to find the calculation for other shares, just search here.
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This article by Simply Wall St is general in nature. We provide comments based on historical data and analyst forecasts only using an impartial method and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any shares and does not take into account your goals or your financial situation. We strive to provide you with long-term focused analysis driven by basic data. Please note that our analysis may not take into account the latest price sensitive company announcements or qualitative material. Simply Wall St has no position in any of the shares mentioned.