A Look At The Fair Value Of LANXESS Aktiengesellschaft (ETR:LXS)

Key Insights

• The projected fair value for LANXESS is €14.85 based on 2 Stage Free Cash Flow to Equity
• LANXESS' €17.62 share price indicates it is trading at similar levels as its fair value estimate
• Analyst price target for LXS is €19.33, which is 30% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of LANXESS Aktiengesellschaft (ETR:LXS) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

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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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (€, Millions)	€261.3m	€164.4m	€116.9m	€93.8m	€81.3m	€74.1m	€69.8m	€67.3m	€66.0m	€65.3m
Growth Rate Estimate Source	Analyst x3	Analyst x5	Est @ -28.88%	Est @ -19.75%	Est @ -13.36%	Est @ -8.88%	Est @ -5.75%	Est @ -3.56%	Est @ -2.02%	Est @ -0.95%
Present Value (€, Millions) Discounted @ 7.9%	€242	€141	€93.1	€69.3	€55.6	€47.0	€41.0	€36.7	€33.3	€30.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €790m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = €65m× (1 + 1.6%) ÷ (7.9%– 1.6%) = €1.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €1.0b÷ ( 1 + 7.9%)¹⁰= €492m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €1.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €17.6, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 LANXESS 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 7.9%, which is based on a levered beta of 1.501. 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.

View our latest analysis for LANXESS

SWOT Analysis for LANXESS

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For LANXESS, we've compiled three relevant items you should consider:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with LANXESS .
2. Future Earnings: How does LXS'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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

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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.