A Look At The Fair Value Of Andrew Peller Limited (TSE:ADW.A)

How far off is Andrew Peller Limited (TSE:ADW.A) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the foreast future cash flows of the company and discounting them back to today's value. This is done using 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.

See our latest analysis for Andrew Peller

Crunching the numbers

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 begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2020	2021	2022	2023	2024	2025	2026	2027	2028	2029
Levered FCF (CA$, Millions)	CA$17.8m	CA$19.4m	CA$20.8m	CA$21.9m	CA$22.9m	CA$23.7m	CA$24.4m	CA$25.0m	CA$25.6m	CA$26.1m
Growth Rate Estimate Source	Est @ 12.59%	Est @ 9.31%	Est @ 7.02%	Est @ 5.41%	Est @ 4.28%	Est @ 3.5%	Est @ 2.95%	Est @ 2.56%	Est @ 2.29%	Est @ 2.1%
Present Value (CA$, Millions) Discounted @ 6.7%	CA$16.7	CA$17.1	CA$17.1	CA$16.9	CA$16.5	CA$16.1	CA$15.5	CA$14.9	CA$14.3	CA$13.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$158m

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 10-year government bond rate of 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.

Terminal Value (TV)= FCF₂₀₂₉ × (1 + g) ÷ (r – g) = CA$26m× (1 + 1.7%) ÷ 6.7%– 1.7%) = CA$529m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$529m÷ ( 1 + 6.7%)¹⁰= CA$277m

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 CA$435m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CA$9.0, the company appears about fair value at a 9.5% 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.

The 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Andrew Peller 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 6.7%, which is based on a levered beta of 0.835. 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.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching 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?" 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. For Andrew Peller, There are three fundamental aspects you should further research:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Andrew Peller .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ADW.A's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 TSX 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. 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. Thank you for reading.