Are Elmos Semiconductor SE (ETR:ELG) Investors Paying Above The Intrinsic Value?

Key Insights

• The projected fair value for Elmos Semiconductor is €79.66 based on 2 Stage Free Cash Flow to Equity
• Current share price of €102 suggests Elmos Semiconductor is potentially 28% overvalued
• Our fair value estimate is 21% lower than Elmos Semiconductor's analyst price target of €101

Today we will run through one way of estimating the intrinsic value of Elmos Semiconductor SE (ETR:ELG) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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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The Method

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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (€, Millions)	€81.7m	€87.0m	€90.9m	€94.3m	€97.1m	€99.6m	€101.9m	€104.0m	€106.0m	€107.9m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Est @ 4.54%	Est @ 3.64%	Est @ 3.02%	Est @ 2.58%	Est @ 2.27%	Est @ 2.06%	Est @ 1.91%	Est @ 1.81%
Present Value (€, Millions) Discounted @ 8.3%	€75.4	€74.2	€71.6	€68.6	€65.2	€61.8	€58.4	€55.0	€51.8	€48.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €631m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.6%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.3%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = €108m× (1 + 1.6%) ÷ (8.3%– 1.6%) = €1.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €1.6b÷ ( 1 + 8.3%)¹⁰= €735m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €1.4b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of €102, the company appears slightly overvalued at the time of writing. 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.

The 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 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 Elmos Semiconductor 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 8.3%, which is based on a levered beta of 1.597. 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 Elmos Semiconductor

SWOT Analysis for Elmos Semiconductor

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Elmos Semiconductor, we've put together three additional factors you should look at:

1. Risks: As an example, we've found 1 warning sign for Elmos Semiconductor that you need to consider before investing here.
2. Future Earnings: How does ELG'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the XTRA every day. If you want to find the calculation for other stocks 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.