Nestlé SA (VTX:NESN) shares could be 37% below their estimated intrinsic value

Key findings

• The estimated fair value of Nestlé is CHF146, based on the 2-step free cash flow to equity

• Nestlé is estimated to be 37% undervalued based on the current share price of CHF 91.72

• Our fair value estimate is 38% above Nestlé analysts’ price target of CHF 106.

Does Nestlé SA’s (VTX:NESN) share price in June reflect its actual value? Today we’ll estimate the stock’s intrinsic value by taking the expected future cash flows and discounting them to today’s value. One way to do this is by applying the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too difficult to follow, as you’ll see from our example!

We would like to point out that there are many ways to value a company and that each method, like the DCF, has advantages and disadvantages in certain scenarios. If you still have questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Nestlé

What is the estimated value?

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to get estimates for 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 that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, we discount the value of these future cash flows to their estimated value in today’s dollars:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 110 billion francs

The story goes on

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 0.2%. We discount the terminal cash flows to today’s value at a cost of equity of 3.9%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = 15 billion CHF × (1 + 0.2 %) ÷ (3.9 % – 0.2 %) = 398 billion CHF

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 398 billion CHF ÷ (1 + 3.9%)¹⁰= 272 billion francs

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is CHF 382 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CHF 91.7, the company appears to be quite valuable at a 37% discount to the current share price. However, keep in mind that this is only an approximate valuation and as with any complex formula, where there’s garbage in, there’s garbage out.

The assumptions

The key 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. DCF also doesn’t take into account the possible cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we consider Nestlé 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 3.9%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies, with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Nestlé

Strength

weakness

Opportunity

Danger

Go on:

While a company’s valuation is important, it is only one of many factors you need to evaluate a company. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of 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 differently, or its cost of equity or risk-free rate changes significantly, the outcome may be very different. Why is the intrinsic value higher than the current share price? For Nestlé, we have compiled three other aspects that you should investigate further:

1. Risks: For this purpose, you should consult the 1 warning sign we discovered it at Nestlé.

2. Future income: How is NESN’s growth rate compared to competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.

3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS. The Simply Wall St app performs a daily discounted cash flow valuation for every stock on the SWX. If you want to find the calculation for other stocks, just search here.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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