Estimating The Intrinsic Value Of Shawcor Ltd. (TSE:SCL)

Key Insights

• Shawcor's estimated fair value is CA$14.72 based on 2 Stage Free Cash Flow to Equity
• With CA$13.47 share price, Shawcor appears to be trading close to its estimated fair value
• Our fair value estimate is 8.5% lower than Shawcor's analyst price target of CA$16.09

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Shawcor Ltd. (TSE:SCL) 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. 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. 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 Shawcor

The Method

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.

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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CA$, Millions)	CA$38.8m	CA$137.5m	CA$122.0m	CA$113.3m	CA$108.2m	CA$105.4m	CA$104.1m	CA$103.7m	CA$104.1m	CA$104.8m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x1	Est @ -7.14%	Est @ -4.46%	Est @ -2.58%	Est @ -1.27%	Est @ -0.35%	Est @ 0.30%	Est @ 0.75%
Present Value (CA$, Millions) Discounted @ 11%	CA$35.0	CA$112	CA$89.5	CA$75.0	CA$64.6	CA$56.8	CA$50.6	CA$45.5	CA$41.1	CA$37.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$607m

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)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CA$105m× (1 + 1.8%) ÷ (11%– 1.8%) = CA$1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$1.2b÷ ( 1 + 11%)¹⁰= CA$420m

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$1.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$13.5, the company appears about fair value at a 8.5% 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

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 Shawcor 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 1.526. 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 Shawcor

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. For Shawcor, we've compiled three essential aspects you should further examine:

1. Risks: You should be aware of the 1 warning sign for Shawcor we've uncovered before considering an investment in the company.
2. Future Earnings: How does SCL'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 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.

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.