Stock Analysis

Is There An Opportunity With SNC-Lavalin Group Inc.'s (TSE:SNC) 48% Undervaluation?

  •  Updated
TSX:SNC
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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. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for SNC-Lavalin Group

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. To begin with, we have to get estimates of 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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (CA$, Millions) CA$237.0m CA$390.7m CA$616.0m CA$680.0m CA$726.4m CA$764.4m CA$796.0m CA$822.6m CA$845.6m CA$866.1m
Growth Rate Estimate Source Analyst x4 Analyst x3 Analyst x1 Analyst x1 Est @ 6.82% Est @ 5.24% Est @ 4.12% Est @ 3.35% Est @ 2.8% Est @ 2.42%
Present Value (CA$, Millions) Discounted @ 7.4% CA$221 CA$339 CA$498 CA$512 CA$509 CA$499 CA$484 CA$466 CA$446 CA$425

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$4.4b

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 7.4%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CA$866m× (1 + 1.5%) ÷ (7.4%– 1.5%) = CA$15b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$15b÷ ( 1 + 7.4%)10= CA$7.4b

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$12b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CA$34.8, the company appears quite good value at a 48% 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 September 2nd 2021

The 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 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 7.4%, which is based on a levered beta of 1.237. 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For SNC-Lavalin Group, there are three relevant items you should further examine:

  1. Risks: We feel that you should assess the 1 warning sign for SNC-Lavalin Group we've flagged before making an investment in the company.
  2. Future Earnings: How does SNC'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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