A look at the fair value of Alcon Inc. (VTX:ALC)

Key findings

• The estimated fair value of Alcon is CHF95.36 based on the 2-step Free Cash Flow to Equity
• With a share price of CHF 81.72, Alcon appears to be trading close to its estimated fair value
• Our fair value estimate is 13% above Alcon’s analyst price target of $84.52.

How far is Alcon Inc. (VTX:ALC) from its intrinsic value? Using the most recent financial data, we will check whether the stock is fairly valued by projecting its future cash flows and then discounting them to today’s value. To do this, we will use the Discounted Cash Flow (DCF) model. There’s actually not too much involved in it, even though it may seem quite complex.

Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. If you still have pressing questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Alcon

The model

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 estimate the next ten years’ worth 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.

A DCF is all about the idea that a dollar in the future is worth less than a dollar today. So we discount the value of these future cash flows to their estimated value in today’s dollars:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 17 billion US dollars

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value that takes into account all future cash flows after the first period. 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 4.7%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = $2.5 billion × (1 + 0.2%) ÷ (4.7% – 0.2%) = $56 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 56 billion US dollars ÷ (1 + 4.7%)¹⁰= 36 billion US dollars

The total value or equity value is then the sum of the present value of future cash flows, which in this case is $53 billion. The final step is to divide the equity value by the number of shares outstanding. Relative to the current share price of CHF 81.7, the company appears to be roughly fairly valued at a 14% 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 is garbage in, there is 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 potential 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 Alcon 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 4.7%, which is based on a leveraged beta of 0.980. 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 Alcon

Next Steps:

While the DCF calculation 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. The best thing to do is to apply different cases and assumptions and see how they affect the company’s valuation. If a company grows differently or its cost of equity or risk-free rate changes significantly, the outcome can be very different. For Alcon, there are three key factors you should examine more closely:

1. Financial health: Does ALC have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks for key factors such as debt and risk.
2. Future income: How is ALC’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 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 out on!

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.

Do you have feedback on this article? Are you concerned about the content? Get in touch directly from us. Alternatively, send an email to editorial-team (at) simplywallst.com.

This Simply Wall St article is of a general nature. We comment solely on the basis of 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.

Do you have feedback on this article? Are you interested in the content? Contact us directly. Alternatively, send an email to [email protected]