Capricorn Metals Ltd's (ASX:CMM) Intrinsic Value Is Potentially 95% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Capricorn Metals fair value estimate is AU$8.73
• Current share price of AU$4.49 suggests Capricorn Metals is potentially 49% undervalued
• Analyst price target for CMM is AU$4.91 which is 44% below our fair value estimate

Does the January share price for Capricorn Metals Ltd (ASX:CMM) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 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 Capricorn Metals

What's The Estimated Valuation?

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. 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.

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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$90.7m	-AU$159.9m	AU$153.7m	AU$229.0m	AU$230.0m	AU$232.0m	AU$234.9m	AU$238.5m	AU$242.5m	AU$246.8m
Growth Rate Estimate Source	Analyst x4	Analyst x3	Analyst x4	Analyst x2	Analyst x2	Est @ 0.90%	Est @ 1.26%	Est @ 1.50%	Est @ 1.68%	Est @ 1.80%
Present Value (A$, Millions) Discounted @ 7.5%	AU$84.3	-AU$138	AU$124	AU$171	AU$160	AU$150	AU$141	AU$133	AU$126	AU$119

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.1b

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$247m× (1 + 2.1%) ÷ (7.5%– 2.1%) = AU$4.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$4.6b÷ ( 1 + 7.5%)¹⁰= AU$2.2b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$3.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$4.5, the company appears quite undervalued at a 49% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Capricorn Metals 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 7.5%, which is based on a levered beta of 1.094. 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 Capricorn Metals

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize 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. Can we work out why the company is trading at a discount to intrinsic value? For Capricorn Metals, we've put together three essential factors you should further examine:

1. Risks: We feel that you should assess the 3 warning signs for Capricorn Metals we've flagged before making an investment in the company.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CMM'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 ASX 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. 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.