An Intrinsic Calculation For LafargeHolcim Ltd (VTX:LHN) Suggests It's 41% Undervalued
Simply Wall St
How far off is LafargeHolcim Ltd (VTX:LHN) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the foreast future cash flows of the company and discounting them back to today's value. I will be using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
Levered FCF (CHF, Millions)
CHF2.6b
CHF2.9b
CHF3.2b
CHF3.6b
CHF3.8b
CHF4.1b
CHF4.3b
CHF4.5b
CHF4.7b
CHF4.9b
Growth Rate Estimate Source
Analyst x13
Analyst x8
Analyst x4
Analyst x1
Est @ 7.96%
Est @ 6.56%
Est @ 5.57%
Est @ 4.88%
Est @ 4.4%
Est @ 4.06%
Present Value (CHF, Millions) Discounted @ 10.48%
CHF2.3k
CHF2.4k
CHF2.4k
CHF2.4k
CHF2.3k
CHF2.2k
CHF2.1k
CHF2.0k
CHF1.9k
CHF1.8k
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF)= CHF22.0b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 3.3%. We discount the terminal cash flows to today's value at a cost of equity of 10.5%.
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = CHFCHF70b ÷ ( 1 + 10.5%)10 = CHF25.98b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CHF47.94b. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of CHF79.22. Relative to the current share price of CHF46.77, the company appears quite undervalued at a 41% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
SWX:LHN Intrinsic value, September 2nd 2019
Important assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at LafargeHolcim 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 accounts for debt. In this calculation we've used 10.5%, which is based on a levered beta of 1.21. Beta is a measure of a stock's volatility, compared 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.
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 company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price to differ from the intrinsic value? For LafargeHolcim, I've put together three relevant aspects you should look at:
Future Earnings: How does LHN's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of LHN? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every CH stock every day, so if you want to find the intrinsic value of any other stock just search here.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
