U.S. Markets closed

# Calculating The Fair Value Of Compagnie Générale des Établissements Michelin (EPA:ML)

Want to participate in a short research study? Help shape the future of investing tools and you could win a \$250 gift card!

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Compagnie Générale des Établissements Michelin (EPA:ML) as an investment opportunity by estimating the company’s future cash flows and discounting them to their present value. I will use the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not February 2019 then I highly recommend you check out the latest calculation for Compagnie Générale des Établissements Michelin by following the link below.

### The model

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

#### 5-year cash flow forecast

 2019 2020 2021 2022 2023 Levered FCF (€, Millions) €1.33k €1.61k €1.64k €1.76k €1.80k Source Analyst x8 Analyst x8 Analyst x1 Analyst x1 Est @ 1.8% Present Value Discounted @ 12.47% €1.18k €1.27k €1.15k €1.10k €997.94

Present Value of 5-year Cash Flow (PVCF)= €5.7b

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 an annual growth rate equal to the 10-year government bond rate of 0.7%. We discount this to today’s value at a cost of equity of 12.5%.

Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = €1.8b × (1 + 0.7%) ÷ (12.5% – 0.7%) = €15b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €15b ÷ ( 1 + 12.5%)5 = €8.6b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €14b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of €79.36. Compared to the current share price of €94.8, the stock is fair value, maybe slightly overvalued at the time of writing.

### The assumptions

I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Compagnie Générale des Établissements Michelin as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 12.5%, which is based on a levered beta of 1.266. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

### Next Steps:

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. For ML, there are three important aspects you should further research:

1. Financial Health: Does ML have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does ML’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of ML? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every FR stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.