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In this article I am going to calculate the intrinsic value of Abéo SA (EPA:ABEO) by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in September 2018 so be sure check out the updated calculation by following the link below.

Check out our latest analysis for Abéo

The method

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 begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow forecast

Present Value of 5-year Cash Flow (PVCF)= €63.8m

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 0.8%. We discount this to today’s value at a cost of equity of 9.9%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = €23.1m × (1 + 0.8%) ÷ (9.9% – 0.8%) = €256.5m

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = €256.5m ÷ ( 1 + 9.9%)⁵ = €160.3m

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €224.2m. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of €29.83. Compared to the current share price of €35, the stock is fair value, maybe slightly overvalued at the time of writing.

Important assumptions

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 Abéo 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 9.9%, which is based on a levered beta of 0.984. 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.