Is Calfrac Well Services Ltd. (TSE:CFW) Trading At A 42% Discount?

Key Insights

• The projected fair value for Calfrac Well Services is CA$10.10 based on 2 Stage Free Cash Flow to Equity
• Current share price of CA$5.87 suggests Calfrac Well Services is potentially 42% undervalued
• Analyst price target for CFW is CA$7.75 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 Calfrac Well Services Ltd. (TSE:CFW) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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 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.

View our latest analysis for Calfrac Well Services

The Method

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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$130.3m	CA$108.0m	CA$95.5m	CA$88.3m	CA$84.2m	CA$81.9m	CA$80.8m	CA$80.5m	CA$80.7m	CA$81.3m
Growth Rate Estimate Source	Analyst x4	Analyst x2	Est @ -11.52%	Est @ -7.51%	Est @ -4.70%	Est @ -2.73%	Est @ -1.35%	Est @ -0.39%	Est @ 0.29%	Est @ 0.76%
Present Value (CA$, Millions) Discounted @ 12%	CA$117	CA$86.4	CA$68.3	CA$56.5	CA$48.2	CA$41.9	CA$37.0	CA$33.0	CA$29.6	CA$26.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$544m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$81m× (1 + 1.9%) ÷ (12%– 1.9%) = CA$833m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$833m÷ ( 1 + 12%)¹⁰= CA$273m

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$817m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$5.9, the company appears quite undervalued at a 42% 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.

Important 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Calfrac Well 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 12%, which is based on a levered beta of 1.989. 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 Calfrac Well Services

Moving On:

Although the valuation of a company is important, it 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 Calfrac Well Services, there are three relevant aspects you should explore:

1. Risks: Case in point, we've spotted 3 warning signs for Calfrac Well Services you should be aware of, and 2 of them are a bit concerning.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CFW'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.