Estimating The Fair Value Of Burgundy Diamond Mines Limited (ASX:BDM)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Burgundy Diamond Mines fair value estimate is AU$0.09
• With AU$0.099 share price, Burgundy Diamond Mines appears to be trading close to its estimated fair value
• Industry average of 41% suggests Burgundy Diamond Mines' peers are currently trading at a higher premium to fair value

In this article we are going to estimate the intrinsic value of Burgundy Diamond Mines Limited (ASX:BDM) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Burgundy Diamond Mines

The Calculation

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 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$25.9m	US$6.97m	US$11.9m	US$8.13m	US$6.38m	US$5.46m	US$4.96m	US$4.68m	US$4.53m	US$4.46m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -31.91%	Est @ -21.57%	Est @ -14.32%	Est @ -9.25%	Est @ -5.70%	Est @ -3.22%	Est @ -1.48%
Present Value ($, Millions) Discounted @ 10%	US$23.5	US$5.8	US$9.0	US$5.6	US$4.0	US$3.1	US$2.5	US$2.2	US$1.9	US$1.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$59m

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 (2.6%) 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 10%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$4.5m× (1 + 2.6%) ÷ (10%– 2.6%) = US$62m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$62m÷ ( 1 + 10%)¹⁰= US$24m

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$83m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$0.1, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Burgundy Diamond Mines 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 10%, which is based on a levered beta of 1.804. 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 Burgundy Diamond Mines

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Burgundy Diamond Mines, we've put together three additional elements you should consider:

1. Risks: We feel that you should assess the 2 warning signs for Burgundy Diamond Mines we've flagged before making an investment in the company.
2. Future Earnings: How does BDM'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. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock 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.