Is There An Opportunity With Boyd Group Services Inc.'s (TSE:BYD) 32% Undervaluation?

Key Insights

• Boyd Group Services' estimated fair value is US$310 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$210 suggests Boyd Group Services is 32% undervalued
• Analyst price target for BYD is US$229 which is 26% below our fair value estimate

How far off is Boyd Group Services Inc. (TSE:BYD) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

Check out our latest analysis for Boyd Group Services

Is Boyd Group Services Fairly Valued?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$184.7m	US$210.0m	US$251.0m	US$279.3m	US$302.8m	US$322.2m	US$338.2m	US$351.7m	US$363.3m	US$373.6m
Growth Rate Estimate Source	Analyst x3	Analyst x2	Analyst x1	Est @ 11.29%	Est @ 8.41%	Est @ 6.39%	Est @ 4.98%	Est @ 3.99%	Est @ 3.30%	Est @ 2.82%
Present Value ($, Millions) Discounted @ 7.7%	US$171	US$181	US$201	US$207	US$209	US$206	US$201	US$194	US$186	US$178

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.9b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 7.7%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$374m× (1 + 1.7%) ÷ (7.7%– 1.7%) = US$6.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$6.3b÷ ( 1 + 7.7%)¹⁰= US$3.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$4.9b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$210, the company appears quite good value at a 32% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Boyd Group Services 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 7.7%, which is based on a levered beta of 1.004. 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.

SWOT Analysis for Boyd Group Services

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Boyd Group Services, we've compiled three fundamental aspects you should look at:

1. Risks: Case in point, we've spotted 3 warning signs for Boyd Group Services you should be aware of, and 1 of them is potentially serious.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for BYD's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

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This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.