Are Investors Undervaluing Perenti Global Limited (ASX:PRN) By 44%?

Today we will run through one way of estimating the intrinsic value of Perenti Global Limited (ASX:PRN) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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 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 Perenti Global

What's the estimated valuation?

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. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (A$, Millions)	AU$76.8m	AU$45.3m	AU$103.6m	AU$114.7m	AU$124.0m	AU$131.8m	AU$138.4m	AU$144.1m	AU$149.1m	AU$153.7m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x2	Est @ 10.74%	Est @ 8.12%	Est @ 6.29%	Est @ 5%	Est @ 4.11%	Est @ 3.48%	Est @ 3.04%
Present Value (A$, Millions) Discounted @ 11%	AU$69.5	AU$37.1	AU$76.7	AU$76.9	AU$75.2	AU$72.3	AU$68.7	AU$64.7	AU$60.6	AU$56.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$658m

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 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = AU$154m× (1 + 2.0%) ÷ (11%– 2.0%) = AU$1.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$1.8b÷ ( 1 + 11%)¹⁰= AU$676m

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$1.3b. 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$1.1, the company appears quite good value at a 44% 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

Now 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 Perenti Global 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 11%, which is based on a levered beta of 1.629. 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.

Looking Ahead:

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. 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. What is the reason for the share price sitting below the intrinsic value? For Perenti Global, there are three further aspects you should consider:

1. Risks: As an example, we've found 4 warning signs for Perenti Global (1 is a bit concerning!) that you need to consider before investing here.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PRN'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. 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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