Akzo Nobel N.V. (AMS:AKZA) Shares Could Be 35% Below Their Intrinsic Value Estimate

Key Insights

• Akzo Nobel's estimated fair value is €113 based on 2 Stage Free Cash Flow to Equity

• Akzo Nobel is estimated to be 35% undervalued based on current share price of €73.40

• Our fair value estimate is 38% higher than Akzo Nobel's analyst price target of €82.21

How far off is Akzo Nobel N.V. (AMS:AKZA) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Akzo Nobel

The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, 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)	€882.0m	€904.4m	€950.1m	€1.18b	€1.27b	€1.33b	€1.37b	€1.41b	€1.44b	€1.46b
Growth Rate Estimate Source	Analyst x8	Analyst x7	Analyst x7	Analyst x4	Analyst x2	Est @ 4.84%	Est @ 3.51%	Est @ 2.58%	Est @ 1.93%	Est @ 1.47%
Present Value (€, Millions) Discounted @ 7.1%	€824	€789	€774	€896	€900	€882	€852	€816	€777	€737

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €8.2b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 0.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = €1.5b× (1 + 0.4%) ÷ (7.1%– 0.4%) = €22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €22b÷ ( 1 + 7.1%)¹⁰= €11b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €19b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €73.4, the company appears quite good value at a 35% 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

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Akzo Nobel 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 7.1%, which is based on a levered beta of 1.122. 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 Akzo Nobel

Strength

• Debt is well covered by earnings.

Weakness

• Earnings declined over the past year.

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

Opportunity

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

• Trading below our estimate of fair value by more than 20%.

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by earnings and cashflows.

• Annual revenue is forecast to grow slower than the Dutch market.

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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Akzo Nobel, there are three fundamental aspects you should consider:

1. Risks: You should be aware of the 3 warning signs for Akzo Nobel (2 shouldn't be ignored!) we've uncovered before considering an investment in the company.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AKZA's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ENXTAM every day. If you want to find the calculation for other stocks 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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