Estimating The Fair Value Of IsoEnergy Ltd. (TSE:ISO)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, IsoEnergy fair value estimate is CA$2.54
• With CA$2.09 share price, IsoEnergy appears to be trading close to its estimated fair value
• IsoEnergy's peers seem to be trading at a higher discount to fair value based onthe industry average of 22%

Does the March share price for IsoEnergy Ltd. (TSE:ISO) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for IsoEnergy

Step By Step Through The Calculation

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 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CA$, Millions)	-CA$17.0m	-CA$22.0m	CA$10.0m	CA$14.3m	CA$18.8m	CA$22.9m	CA$26.7m	CA$30.0m	CA$32.7m	CA$35.1m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Est @ 43.20%	Est @ 30.95%	Est @ 22.37%	Est @ 16.37%	Est @ 12.17%	Est @ 9.22%	Est @ 7.17%
Present Value (CA$, Millions) Discounted @ 6.9%	-CA$15.9	-CA$19.2	CA$8.2	CA$11.0	CA$13.4	CA$15.4	CA$16.7	CA$17.5	CA$17.9	CA$18.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$83m

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 (2.4%) 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 6.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CA$35m× (1 + 2.4%) ÷ (6.9%– 2.4%) = CA$789m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$789m÷ ( 1 + 6.9%)¹⁰= CA$404m

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$487m. 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$2.1, the company appears about fair value at a 18% 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.

Important 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 IsoEnergy 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 6.9%, which is based on a levered beta of 1.051. 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 IsoEnergy

Moving On:

Whilst important, the DCF calculation 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For IsoEnergy, we've compiled three additional aspects you should look at:

1. Risks: For example, we've discovered 1 warning sign for IsoEnergy that you should be aware of before investing here.
2. Future Earnings: How does ISO'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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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.