Calculating The Intrinsic Value Of Spot Coffee (Canada) Ltd. (CVE:SPP)

Key Insights

• Spot Coffee (Canada)'s estimated fair value is CA$0.061 based on 2 Stage Free Cash Flow to Equity
• Spot Coffee (Canada)'s CA$0.05 share price indicates it is trading at similar levels as its fair value estimate
• Spot Coffee (Canada)'s peers are currently trading at a premium of 151% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Spot Coffee (Canada) Ltd. (CVE:SPP) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

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.

View our latest analysis for Spot Coffee (Canada)

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$826.8k	CA$863.5k	CA$895.0k	CA$922.6k	CA$947.6k	CA$970.6k	CA$992.4k	CA$1.01m	CA$1.03m	CA$1.05m
Growth Rate Estimate Source	Est @ 5.57%	Est @ 4.44%	Est @ 3.65%	Est @ 3.09%	Est @ 2.70%	Est @ 2.43%	Est @ 2.24%	Est @ 2.11%	Est @ 2.02%	Est @ 1.95%
Present Value (CA$, Millions) Discounted @ 11%	CA$0.7	CA$0.7	CA$0.7	CA$0.6	CA$0.6	CA$0.5	CA$0.5	CA$0.4	CA$0.4	CA$0.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$5.5m

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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$1.1m× (1 + 1.8%) ÷ (11%– 1.8%) = CA$12m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$12m÷ ( 1 + 11%)¹⁰= CA$4.3m

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$9.9m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$0.05, the company appears about fair value at a 18% 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.

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. 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 Spot Coffee (Canada) 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 11%, which is based on a levered beta of 1.502. 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 Spot Coffee (Canada)

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Spot Coffee (Canada), we've compiled three additional elements you should assess:

1. Risks: To that end, you should be aware of the 3 warning signs we've spotted with Spot Coffee (Canada) .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SPP'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 TSXV every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.