Stock Analysis

BRP Inc. (TSE:DOO) Shares Could Be 46% Below Their Intrinsic Value Estimate

TSX:DOO
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Key Insights

  • The projected fair value for BRP is CA$181 based on 2 Stage Free Cash Flow to Equity
  • BRP is estimated to be 46% undervalued based on current share price of CA$97.93
  • Analyst price target for DOO is CA$139 which is 23% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of BRP Inc. (TSE:DOO) as an investment opportunity 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

Check out our latest analysis for BRP

The Model

We're 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 a stable growth rate. 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (CA$, Millions) CA$488.2m CA$991.6m CA$814.7m CA$1.13b CA$1.37b CA$1.37b CA$1.38b CA$1.39b CA$1.41b CA$1.43b
Growth Rate Estimate Source Analyst x8 Analyst x8 Analyst x8 Analyst x2 Analyst x1 Analyst x1 Est @ 0.63% Est @ 0.98% Est @ 1.23% Est @ 1.40%
Present Value (CA$, Millions) Discounted @ 9.7% CA$445 CA$824 CA$618 CA$784 CA$862 CA$787 CA$722 CA$665 CA$613 CA$567

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$6.9b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.7%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CA$1.4b× (1 + 1.8%) ÷ (9.7%– 1.8%) = CA$18b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$18b÷ ( 1 + 9.7%)10= CA$7.3b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CA$14b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CA$97.9, the company appears quite undervalued at a 46% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
TSX:DOO Discounted Cash Flow May 17th 2023

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 BRP 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 9.7%, which is based on a levered beta of 1.326. 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 BRP

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
Weakness
  • Earnings growth over the past year is below its 5-year average.
  • Dividend is low compared to the top 25% of dividend payers in the Leisure market.
Opportunity
  • Annual revenue is forecast to grow faster than the Canadian market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to grow slower than the Canadian market.

Looking Ahead:

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?" 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. Why is the intrinsic value higher than the current share price? For BRP, we've compiled three important aspects you should look at:

  1. Risks: To that end, you should learn about the 2 warning signs we've spotted with BRP (including 1 which is significant) .
  2. Future Earnings: How does DOO'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.

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

Find out whether BRP 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.

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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.