Is PFB Corporation (TSE:PFB) Trading At A 42% Discount?

Does the September share price for PFB Corporation (TSE:PFB) 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. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for PFB

Step by step through 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 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 (CA$, Millions)	CA$14.9m	CA$14.7m	CA$14.6m	CA$14.7m	CA$14.7m	CA$14.9m	CA$15.1m	CA$15.2m	CA$15.5m	CA$15.7m
Growth Rate Estimate Source	Analyst x1	Est @ -1.39%	Est @ -0.47%	Est @ 0.17%	Est @ 0.61%	Est @ 0.93%	Est @ 1.15%	Est @ 1.3%	Est @ 1.41%	Est @ 1.48%
Present Value (CA$, Millions) Discounted @ 9.1%	CA$13.7	CA$12.4	CA$11.3	CA$10.3	CA$9.5	CA$8.8	CA$8.2	CA$7.6	CA$7.1	CA$6.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$95m

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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 9.1%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = CA$16m× (1 + 1.7%) ÷ (9.1%– 1.7%) = CA$215m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$215m÷ ( 1 + 9.1%)¹⁰= CA$90m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CA$185m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$16.1, the company appears quite good value at a 42% 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.

Important assumptions

We would point out that 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 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 PFB 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 9.1%, which is based on a levered beta of 1.235. 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.

Moving On:

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. 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?" 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 PFB, there are three pertinent aspects you should assess:

1. Risks: For example, we've discovered 2 warning signs for PFB that you should be aware of before investing here.
2. Future Earnings: How does PFB'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 Canadian stock every day, so if you want to find the intrinsic value of any other stock 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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