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Are Investors Undervaluing Fresenius SE & Co. KGaA (ETR:FRE) By 36%?

Today we will run through one way of estimating the intrinsic value of Fresenius SE & Co. KGaA (ETR:FRE) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Fresenius SE KGaA

Step By Step Through The Calculation

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.

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Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF (€, Millions)

€2.20b

€2.58b

€2.89b

€3.32b

€2.51b

€2.05b

€1.79b

€1.64b

€1.54b

€1.47b

Growth Rate Estimate Source

Analyst x7

Analyst x7

Analyst x3

Analyst x2

Analyst x1

Est @ -18.07%

Est @ -12.60%

Est @ -8.77%

Est @ -6.09%

Est @ -4.22%

Present Value (€, Millions) Discounted @ 7.9%

€2.0k

€2.2k

€2.3k

€2.5k

€1.7k

€1.3k

€1.1k

€890

€774

€687

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €15b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (0.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.9%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = €1.5b× (1 + 0.2%) ÷ (7.9%– 0.2%) = €19b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €19b÷ ( 1 + 7.9%)10= €8.9b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is €24b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of €27.4, the company appears quite undervalued at a 36% 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.

dcf
dcf

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 Fresenius SE KGaA 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 7.9%, which is based on a levered beta of 1.306. 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 Fresenius SE KGaA

Strength

  • Debt is well covered by earnings.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings declined over the past year.

  • Dividend is low compared to the top 25% of dividend payers in the Healthcare market.

Opportunity

  • Annual earnings are forecast to grow faster than the German market.

  • Good value based on P/E ratio and estimated fair value.

Threat

  • Debt is not well covered by operating cash flow.

  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Fresenius SE KGaA, we've put together three essential factors you should assess:

  1. Risks: We feel that you should assess the 1 warning sign for Fresenius SE KGaA we've flagged before making an investment in the company.

  2. Future Earnings: How does FRE'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.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every German stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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