Are Investors Undervaluing Uni-Select Inc. (TSE:UNS) By 45%?

Does the August share price for Uni-Select Inc. (TSE:UNS) reflect what it’s really worth? Today, we will estimate the stock’s intrinsic value by taking the expected future cash flows and discounting them to today’s value. Our analysis will employ the Discounted Cash Flow (DCF) model. 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.

See our latest analysis for Uni-Select

Is Uni-Select fairly valued?

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$48.3m US$50.2m US$51.7m US$53.1m US$54.3m US$55.5m US$56.6m US$57.7m US$58.7m US$59.8m
Growth Rate Estimate Source Analyst x4 Analyst x1 Est @ 3.05% Est @ 2.63% Est @ 2.34% Est @ 2.14% Est @ 1.99% Est @ 1.89% Est @ 1.82% Est @ 1.77%
Present Value ($, Millions) Discounted @ 14% US$42.4 US$38.8 US$35.2 US$31.8 US$28.6 US$25.7 US$23.1 US$20.7 US$18.5 US$16.6

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$281m

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. 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 14%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$60m× (1 + 1.7%) ÷ (14%– 1.7%) = US$506m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$506m÷ ( 1 + 14%)10= US$140m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$421m. 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$7.3, the company appears quite good value at a 45% 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
TSX:UNS Discounted Cash Flow August 6th 2020

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. 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 Uni-Select 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 14%, which is based on a levered beta of 2.000. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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. What is the reason for the share price sitting below the intrinsic value? For Uni-Select, we’ve compiled three relevant aspects you should assess:

  1. Risks: Every company has them, and we’ve spotted 2 warning signs for Uni-Select (of which 1 doesn’t sit too well with us!) you should know about.
  2. Future Earnings: How does UNS’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 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 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.
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