A Look At The Fair Value Of Sweco AB (publ) (STO:SWEC B)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Sweco fair value estimate is kr166
• Current share price of kr148 suggests Sweco is potentially trading close to its fair value
• Analyst price target for SWEC B is kr190, which is 14% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Sweco AB (publ) (STO:SWEC B) as an investment opportunity by taking the expected future cash flows and discounting them to their present 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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Step By Step Through The Calculation

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. 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) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (SEK, Millions)	kr2.82b	kr3.26b	kr3.25b	kr3.26b	kr3.29b	kr3.32b	kr3.36b	kr3.41b	kr3.46b	kr3.51b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Est @ -0.23%	Est @ 0.35%	Est @ 0.75%	Est @ 1.04%	Est @ 1.24%	Est @ 1.37%	Est @ 1.47%	Est @ 1.54%
Present Value (SEK, Millions) Discounted @ 6.8%	kr2.6k	kr2.9k	kr2.7k	kr2.5k	kr2.4k	kr2.2k	kr2.1k	kr2.0k	kr1.9k	kr1.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr23b

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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = kr3.5b× (1 + 1.7%) ÷ (6.8%– 1.7%) = kr71b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= kr71b÷ ( 1 + 6.8%)¹⁰= kr37b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is kr60b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of kr148, the company appears about fair value at a 11% 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.

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 Sweco 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 6.8%, which is based on a levered beta of 1.200. 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 Sweco

SWOT Analysis for Sweco

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Sweco, we've compiled three additional factors you should consider:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Sweco , and understanding it should be part of your investment process.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SWEC B's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. 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 OM 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.