Is There An Opportunity With Resolute Mining Limited's (ASX:RSG) 49.45% Undervaluation?

January 12, 2019

In this article I am going to calculate the intrinsic value of Resolute Mining Limited (ASX:RSG) 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 Flows (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for Resolute Mining by following the link below.

Check out our latest analysis for Resolute Mining

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The model

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow estimate

	2019	2020	2021	2022	2023
Levered FCF (A$, Millions)	A$78.26	A$10.00	A$145.50	A$147.05	A$148.61
Source	Analyst x2	Analyst x2	Analyst x2	Est @ 1.06%	Est @ 1.06%
Present Value Discounted @ 9.89%	A$71.22	A$8.28	A$109.66	A$100.86	A$92.76

Present Value of 5-year Cash Flow (PVCF)= AU$383m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.8%). In the same way as with the 5-year 'growth' period, we discount this to today's value at a cost of equity of 9.9%.

Terminal Value (TV) = FCF₂₀₂₃ × (1 + g) ÷ (r – g) = AU$149m × (1 + 2.8%) ÷ (9.9% – 2.8%) = AU$2.1b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = AU$2.1b ÷ ( 1 + 9.9%)⁵ = AU$1.3b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is AU$1.7b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of A$2.27. Relative to the current share price of A$1.15, the stock is quite undervalued at a 49% discount to what it is available for right now.

ASX:RSG Intrinsic Value Export January 12th 19

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Resolute Mining as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I've used 9.9%, which is based on a levered beta of 0.984. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For RSG, I've compiled three pertinent factors you should further examine:

Financial Health: Does RSG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does RSG'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.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of RSG? 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 for every stock on the ASX every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.