UK markets close in 4 hours 7 minutes
  • FTSE 100

    7,208.39
    +4.56 (+0.06%)
     
  • FTSE 250

    23,058.86
    +90.12 (+0.39%)
     
  • AIM

    1,238.35
    +0.89 (+0.07%)
     
  • GBP/EUR

    1.1856
    +0.0037 (+0.32%)
     
  • GBP/USD

    1.3825
    +0.0098 (+0.71%)
     
  • BTC-GBP

    44,942.84
    +470.97 (+1.06%)
     
  • CMC Crypto 200

    1,450.41
    -1.22 (-0.08%)
     
  • S&P 500

    4,486.46
    +15.09 (+0.34%)
     
  • DOW

    35,258.61
    -36.15 (-0.10%)
     
  • CRUDE OIL

    83.54
    +1.10 (+1.33%)
     
  • GOLD FUTURES

    1,777.50
    +11.80 (+0.67%)
     
  • NIKKEI 225

    29,215.52
    +190.06 (+0.65%)
     
  • HANG SENG

    25,787.21
    +377.46 (+1.49%)
     
  • DAX

    15,485.68
    +11.21 (+0.07%)
     
  • CAC 40

    6,673.20
    +0.10 (+0.00%)
     

A Look At The Fair Value Of Fonterra Co-operative Group Limited (NZSE:FCG)

  • Oops!
    Something went wrong.
    Please try again later.
·5-min read
In this article:
  • Oops!
    Something went wrong.
    Please try again later.

How far off is Fonterra Co-operative Group Limited (NZSE:FCG) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Fonterra Co-operative Group

What's the estimated valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF (NZ$, Millions)

NZ$475.8m

NZ$397.2m

NZ$353.8m

NZ$329.0m

NZ$315.0m

NZ$307.7m

NZ$304.6m

NZ$304.4m

NZ$306.3m

NZ$309.5m

Growth Rate Estimate Source

Est @ -24.51%

Est @ -16.52%

Est @ -10.92%

Est @ -7%

Est @ -4.26%

Est @ -2.34%

Est @ -1%

Est @ -0.06%

Est @ 0.6%

Est @ 1.06%

Present Value (NZ$, Millions) Discounted @ 6.7%

NZ$446

NZ$349

NZ$291

NZ$254

NZ$227

NZ$208

NZ$193

NZ$181

NZ$170

NZ$161

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$2.5b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = NZ$310m× (1 + 2.1%) ÷ (6.7%– 2.1%) = NZ$6.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$6.9b÷ ( 1 + 6.7%)10= NZ$3.6b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$6.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of NZ$3.4, the company appears about fair value at a 8.8% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
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 Fonterra Co-operative Group 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 6.7%, which is based on a levered beta of 0.972. 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.

Looking Ahead:

Whilst important, the DCF calculation 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Fonterra Co-operative Group, there are three essential items you should assess:

  1. Risks: Every company has them, and we've spotted 4 warning signs for Fonterra Co-operative Group (of which 1 is a bit concerning!) you should know about.

  2. 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 is out there you may be missing!

  3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. Simply Wall St updates its DCF calculation for every New Zealander stock every day, so if you want to find the intrinsic value of any other stock just search here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting