Does the January share price for E.ON SE (FRA:EOAN) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by taking the expected future cash flows and discounting them to their present value. I will be using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for E.ON by following the link below.
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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 this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF (€, Millions)||€1.49k||€1.83k||€2.10k||€1.95k||€1.85k|
|Source||Analyst x4||Analyst x2||Analyst x1||Analyst x1||Analyst x1|
|Present Value Discounted @ 8.43%||€1.37k||€1.55k||€1.64k||€1.41k||€1.23k|
Present Value of 5-year Cash Flow (PVCF)= €7.2b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 0.5%. We discount this to today’s value at a cost of equity of 8.4%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = €1.8b × (1 + 0.5%) ÷ (8.4% – 0.5%) = €24b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €24b ÷ ( 1 + 8.4%)5 = €16b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €23b. In the final step we 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) or ADR then we use the equivalent number. This results in an intrinsic value of €10.58. Relative to the current share price of €9.05, the stock is about right, perhaps slightly undervalued at a 14% discount to what it is available for right now.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 E.ON 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 8.4%, which is based on a levered beta of 0.834. 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.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For EOAN, I’ve put together three key factors you should look at:
- Financial Health: Does EOAN 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.
- Future Earnings: How does EOAN’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of EOAN? 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 DE 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 firstname.lastname@example.org.