Swisscom AG's (VTX:SCMN) Intrinsic Value Is Potentially 59% Above Its Share Price

Key Insights

• Swisscom's estimated fair value is CHF797 based on 2 Stage Free Cash Flow to Equity

• Current share price of CHF503 suggests Swisscom is potentially 37% undervalued

• The CHF550 analyst price target for SCMN is 31% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Swisscom AG (VTX:SCMN) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Swisscom

The Model

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 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CHF, Millions)	CHF1.58b	CHF1.59b	CHF1.51b	CHF1.64b	CHF1.53b	CHF1.53b	CHF1.53b	CHF1.53b	CHF1.53b	CHF1.54b
Growth Rate Estimate Source	Analyst x6	Analyst x4	Analyst x4	Analyst x2	Analyst x1	Est @ -0.10%	Est @ -0.01%	Est @ 0.05%	Est @ 0.09%	Est @ 0.12%
Present Value (CHF, Millions) Discounted @ 3.9%	CHF1.5k	CHF1.5k	CHF1.3k	CHF1.4k	CHF1.3k	CHF1.2k	CHF1.2k	CHF1.1k	CHF1.1k	CHF1.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CHF13b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.2%) 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 3.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CHF1.5b× (1 + 0.2%) ÷ (3.9%– 0.2%) = CHF42b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CHF42b÷ ( 1 + 3.9%)¹⁰= CHF29b

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 CHF41b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CHF503, the company appears quite good value at a 37% 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.

dcf

Important Assumptions

Now 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 Swisscom 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 3.9%, which is based on a levered beta of 0.800. 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 Swisscom

Strength

• Earnings growth over the past year exceeded its 5-year average.

• Debt is well covered by earnings and cashflows.

• Dividends are covered by earnings and cash flows.

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

Weakness

• Earnings growth over the past year underperformed the Telecom industry.

Opportunity

• Trading below our estimate of fair value by more than 20%.

Threat

• Annual earnings are forecast to decline for the next 3 years.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess 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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Swisscom, we've put together three additional items you should further examine:

1. Risks: For instance, we've identified 2 warning signs for Swisscom (1 makes us a bit uncomfortable) you should be aware of.

2. Future Earnings: How does SCMN'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 Swiss 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.

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