Is There An Opportunity With Bombardier Inc's (TSE:BBD.B) 48% Undervaluation?

In this article I am going to calculate the intrinsic value of Bombardier Inc (TSE:BBD.B) by projecting its future cash flows and then discounting them 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in November 2018 so be sure check out the updated calculation by following the link below.

See our latest analysis for Bombardier

Crunching the numbers

I'm 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 perpetual stable growth rate. 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 the sum of these cash flows to arrive at a present value estimate.

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.3%. We discount this to today's value at a cost of equity of 11.9%.

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 US$10.9b. 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 in the company’s reported currency of $4.56. However, BBD.B’s primary listing is in Canada, and 1 share of BBD.B in USD represents 1.311 ( USD/ CAD) share of TSX:BBD.A, so the intrinsic value per share in CAD is CA$5.98. Compared to the current share price of CA$3.11, the stock is quite undervalued at a 48% discount to what it is available for right now.

The assumptions

Now 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Bombardier 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 11.9%, which is based on a levered beta of 1.244. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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 BBD.B, there are three relevant factors you should further examine:

1. Financial Health: Does BBD.B 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.
2. Future Earnings: How does BBD.B'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: Are there other high quality stocks you could be holding instead of BBD.B? 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 does a DCF calculation for every CA stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

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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.