A Look At The Fair Value Of Alfa Laval AB (publ) (STO:ALFA)

Key Insights

• Alfa Laval's estimated fair value is kr568 based on 2 Stage Free Cash Flow to Equity
• Current share price of kr490 suggests Alfa Laval is potentially trading close to its fair value
• The kr450 analyst price target for ALFA is 21% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Alfa Laval AB (publ) (STO:ALFA) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Alfa Laval

Crunching The Numbers

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (SEK, Millions)	kr7.62b	kr8.50b	kr9.21b	kr9.71b	kr10.1b	kr10.4b	kr10.7b	kr10.9b	kr11.1b	kr11.3b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x1	Est @ 5.47%	Est @ 4.15%	Est @ 3.23%	Est @ 2.59%	Est @ 2.13%	Est @ 1.82%	Est @ 1.60%
Present Value (SEK, Millions) Discounted @ 5.3%	kr7.2k	kr7.7k	kr7.9k	kr7.9k	kr7.8k	kr7.6k	kr7.4k	kr7.2k	kr7.0k	kr6.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr75b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.1%. We discount the terminal cash flows to today's value at a cost of equity of 5.3%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = kr11b× (1 + 1.1%) ÷ (5.3%– 1.1%) = kr269b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= kr269b÷ ( 1 + 5.3%)¹⁰= kr160b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is kr235b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of kr490, the company appears about fair value at a 14% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

Now 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 Alfa Laval 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 5.3%, which is based on a levered beta of 1.031. 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.

SWOT Analysis for Alfa Laval

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. For Alfa Laval, we've put together three relevant elements you should further examine:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Alfa Laval , and understanding this should be part of your investment process.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ALFA's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other High Quality Alternatives: Do you like a good all-rounder? 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 Swedish stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.