Shares of Trelleborg AB (publ) (STO: TREL B) could be 28% lower than their intrinsic value estimate

How far is Trelleborg AB (publ) (STO: TREL B) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking expected future cash flows and discounting them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!

Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.

See our latest review for Trelleborg

What is the estimated valuation?

We are going to use a two-step 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 “steady growth”. In the first step, we need 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 latest 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) 3.92 kr kr4.33b kr4.15b kr4.04b kr3.96b kr3.91b kr3.89b kr3.87b kr3.86b kr3.86b
Source of estimated growth rate Analyst x4 Analyst x4 Is @ -4.09% East @ -2.76% Is @ -1.83% Is @ -1.19% East @ -0.73% East @ -0.41% Est @ -0.19% East @ -0.03%
Present value (SEK, million) discounted at 5.5% kr3.7k 3.9k kr kr3.5k kr3.3k kr3.0k kr2.8k kr2.7k kr2.5k kr2.4k kr2.3k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = kr30b

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. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (0.3%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 5.5%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = kr3.9b × (1 + 0.3%) ÷ (5.5% – 0.3%) = kr75b

Present value of terminal value (PVTV)= TV / (1 + r)ten= kr75b ÷ (1 + 5.5%)ten= kr44b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is 74b kr. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of 198 kr, the company appears to be slightly undervalued with 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.

OM Discounted Cash Flows: TREL B November 9, 2021

The hypotheses

We would like to stress that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. 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 view Trelleborg 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 5.5%, which is based on a leveraged beta of 1.173. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Looking forward:

While important, calculating DCF is just one of the many factors you need to assess for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Can we understand why the company trades at a discount to its intrinsic value? For Trelleborg, we’ve compiled three basic things you should research further:

  1. Risks: Consider, for example, the ever-present specter of investment risk. We have identified 1 warning sign with Trelleborg and understanding this should be part of your investment process.
  2. Future benefits: How does TREL B’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
  3. 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. Simply Wall St updates its DCF calculation for every Swedish stock every day, so if you want to find the intrinsic value of any other stock just search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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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