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Investors Are Undervaluing HeidelbergCement AG (FRA:HEI) By 23.65%

How far off is HeidelbergCement AG (FRA:HEI) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today’s 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. 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 November 2018 then I highly recommend you check out the latest calculation for HeidelbergCement by following the link below.

View our latest analysis for HeidelbergCement

Step by step through the calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. 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) €1.19k €1.38k €1.50k €1.79k €1.95k
Source Analyst x13 Analyst x11 Analyst x1 Analyst x1 Est @ 8.84%
Present Value Discounted @ 11.92% €1.07k €1.10k €1.07k €1.14k €1.11k

Present Value of 5-year Cash Flow (PVCF)= €5.5b

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (0.5%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 11.9%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €1.9b × (1 + 0.5%) ÷ (11.9% – 0.5%) = €17b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €17b ÷ ( 1 + 11.9%)5 = €9.8b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €15b. 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 €77.04. Relative to the current share price of €58.82, the stock is about right, perhaps slightly undervalued at a 24% discount to what it is available for right now.

DB:HEI Intrinsic Value Export November 26th 18

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at HeidelbergCement 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 11.9%, which is based on a levered beta of 1.203. 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:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For HEI, I’ve compiled three essential aspects you should further research:

  1. Financial Health: Does HEI 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 HEI’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 HEI? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the FRA every 6 hours. If you want to find the calculation for other stocks 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.