Are Investors Undervaluing Coca-Cola HBC AG (LON:CCH) By 27%?
Does Coca-Cola HBC AG (LON: CCH) share price in October reflect what it's really worth? Today we're going to estimate the intrinsic value of the stock by discounting expected future cash flows to today's value. This is done according to the DCF model (Discounted Cash Flow). Models like this may seem beyond the understanding of a layperson, but are fairly easy to follow.
We point out that there are many ways to rate a company and, like with DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of assessment, take a look at the Simply Wall St analytical model.
Check out our latest analysis for Coca-Cola HBC
We will be using a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first phase is generally a higher growth phase that flattens out towards the terminal value and is recorded in the second phase of "steady growth". In the first phase, we need to estimate the cash flows for the business over the next ten years. We use analyst estimates whenever possible. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to reflect that growth tends to slow down more in the early years than in later years.
In general, we assume that a dollar today is more valuable than a dollar in the future. Therefore, the sum of these future cash flows is discounted to today's value:
10-year free cash flow (FCF) estimate
Leverage FCF (€, million)
€ 469.1 million
€ 503.5 million
€ 539.7 million
€ 551.0 million
€ 560.4 million
€ 569.1 million
€ 577.4 million
€ 585.4 million
€ 593.2 million
€ 600.9 million
Source for growth rate estimation
Est @ 1.7%
Est @ 1.56%
Est @ 1.46%
Est @ 1.39%
Est @ 1.34%
Est @ 1.3%
Present value (€, million) discounted by 6.2%
("Est" = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = € 4.0 billion
The second level is also known as Terminal Value. This is the company's cash flow after the first stage. A very conservative growth rate is used that cannot exceed that of any country's GDP growth for a number of reasons. In this case, we used the 5-year average 10-year government bond yield (1.2%) to estimate future growth. Similar to the 10-year growth period, we discount future cash flows to today's value using a cost of equity of 6.2%.
End value (TV) = FCF2030 × (1 + g) ÷ (r - g) = € 601 million × (1 + 1.2%) ÷ (6.2% - 1.2%) = € 12b
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = € 12 billion ÷ (1 + 6.2%) 10 = € 6.7 billion
The total value or equity value is then the sum of the present value of the future cash flows, which in this case is € 11 billion. The final step is to divide the equity value by the number of shares issued. Compared to the current UK share price of £ 19.6, the company appears undervalued at a 27% discount to the current share price. The assumptions in any calculation have a huge impact on the valuation, so it is better to think of this as a rough estimate that is not accurate to the last cent.
The above calculation depends heavily on two assumptions. The first is the discount rate and the other is the cash flows. If you do not agree with this result, try the calculation yourself and play with the assumptions. Nor does the DCF take into account the possible cyclical nature of an industry or the future capital requirements of a company, so it does not give a complete picture of a company's potential performance. Given that we consider Coca-Cola HBC 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) responsible for debt. In this calculation we used 6.2% based on a leverage beta of 0.825. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry-standard average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Assessment is only one side of the coin in building your investment thesis and, ideally, not the only analysis you consider for a company. DCF models are not the be-all and end-all of investment valuation. The best thing to do is to apply different cases and assumptions and see how they affect the company's valuation. For example, changes in the company's cost of equity or the risk-free rate can significantly affect the valuation. Can we find out why the company is trading at a discount on intrinsic value? For Coca-Cola HBC, we've rounded up three additional factors that you should investigate further:
Risks: For example, we've spotted two warning signs of Coca-Cola HBC that you should be aware of before investing here.
Future Outcome: What is CCH's growth rate compared to its competitors and the broader market? Learn more about analyst consensus number for the years to come by interacting with our free analyst growth expectation chart.
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 you might be missing!
PS. Simply Wall St updates its DCF calculation for each UK share daily. So if you want to find out the intrinsic value of any other stock, just search here.
This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell shares and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
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