Stock Analysis

Is SNC-Lavalin Group Inc. (TSE:SNC) Trading At A 47% Discount?

  •  Updated
TSX:SNC
Source: Shutterstock

Today we will run through one way of estimating the intrinsic value of SNC-Lavalin Group Inc. (TSE:SNC) 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 SNC-Lavalin Group

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (CA$, Millions) -CA$6.11m CA$252.5m CA$362.7m CA$616.0m CA$680.0m CA$726.4m CA$764.4m CA$796.0m CA$822.6m CA$845.6m
Growth Rate Estimate Source Analyst x6 Analyst x6 Analyst x3 Analyst x1 Analyst x1 Est @ 6.82% Est @ 5.24% Est @ 4.12% Est @ 3.35% Est @ 2.8%
Present Value (CA$, Millions) Discounted @ 7.3% -CA$5.7 CA$219 CA$293 CA$464 CA$477 CA$475 CA$466 CA$452 CA$435 CA$416

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$3.7b

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = CA$846m× (1 + 1.5%) ÷ (7.3%– 1.5%) = CA$15b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$15b÷ ( 1 + 7.3%)10= CA$7.3b

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$11b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$33.0, the company appears quite undervalued at a 47% 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.

dcf
TSX:SNC Discounted Cash Flow June 1st 2021

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 SNC-Lavalin Group 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 7.3%, which is based on a levered beta of 1.231. 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:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 SNC-Lavalin Group, we've compiled three further items you should consider:

  1. Risks: You should be aware of the 1 warning sign for SNC-Lavalin Group we've uncovered before considering an investment in the company.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SNC's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSX every day. If you want to find the calculation for other stocks just search here.

If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted


Valuation is complex, but we're helping make it simple.

Find out whether SNC-Lavalin Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis