Key Insights

The projected fair value for OC Oerlikon is CHF7.41 based on 2 Stage Free Cash Flow to Equity

OC Oerlikon's CHF4.09 share price signals that it might be 45% undervalued

Analyst price target for OERL is CHF5.87 which is 21% below our fair value estimate

Does the August share price for OC Oerlikon Corporation AG (VTX:OERL) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for OC Oerlikon

The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

Story continues

10-year free cash flow (FCF) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (CHF, Millions) CHF157.0m CHF181.0m CHF197.6m CHF210.2m CHF219.7m CHF226.6m CHF231.6m CHF235.2m CHF237.7m CHF239.5m Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 9.15% Est @ 6.41% Est @ 4.49% Est @ 3.15% Est @ 2.21% Est @ 1.55% Est @ 1.09% Est @ 0.76% Present Value (CHF, Millions) Discounted @ 9.2% CHF144 CHF152 CHF152 CHF148 CHF142 CHF134 CHF125 CHF116 CHF108 CHF99.5

("Est" = FCF growth rate estimated by Simply Wall St)

Present Value of 10-year Cash Flow (PVCF) = CHF1.3b

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 0.01%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF 2033 × (1 + g) ÷ (r – g) = CHF240m× (1 + 0.01%) ÷ (9.2%– 0.01%) = CHF2.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CHF2.6b÷ ( 1 + 9.2%)10= CHF1.1b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CHF2.4b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CHF4.1, the company appears quite undervalued at a 45% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 OC Oerlikon 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 9.2%, which is based on a levered beta of 1.835. 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.

SWOT Analysis for OC Oerlikon

Strength

Debt is well covered by earnings.

Dividend is in the top 25% of dividend payers in the market.

Weakness

Earnings declined over the past year.

Opportunity

Annual earnings are forecast to grow faster than the Swiss market.

Good value based on P/E ratio and estimated fair value.

Threat

Debt is not well covered by operating cash flow.

Dividends are not covered by earnings.

Annual revenue is expected to decline over the next 3 years.

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. Why is the intrinsic value higher than the current share price? For OC Oerlikon, there are three pertinent items you should assess:

Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with OC Oerlikon (at least 2 which are significant) , and understanding them should be part of your investment process. Future Earnings: How does OERL'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: 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!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SWX every day. If you want to find the calculation for other stocks just search here.

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



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.