Key Insights
- Using the 2 Stage Free Cash Flow to Equity, TC Energy fair value estimate is CA$74.49
- TC Energy's CA$61.67 share price indicates it is trading at similar levels as its fair value estimate
- Analyst price target for TRP is CA$61.16 which is 18% below our fair value estimate
Today we will run through one way of estimating the intrinsic value of TC Energy Corporation (TSE:TRP) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for TC Energy
Is TC Energy Fairly Valued?
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (CA$, Millions) | CA$2.09b | CA$3.08b | CA$3.86b | CA$4.57b | CA$5.19b | CA$5.71b | CA$6.15b | CA$6.53b | CA$6.85b | CA$7.13b |
Growth Rate Estimate Source | Analyst x3 | Analyst x2 | Est @ 25.29% | Est @ 18.36% | Est @ 13.50% | Est @ 10.11% | Est @ 7.73% | Est @ 6.06% | Est @ 4.90% | Est @ 4.08% |
Present Value (CA$, Millions) Discounted @ 8.9% | CA$1.9k | CA$2.6k | CA$3.0k | CA$3.3k | CA$3.4k | CA$3.4k | CA$3.4k | CA$3.3k | CA$3.2k | CA$3.1k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$31b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (2.2%) 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 8.9%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CA$7.1b× (1 + 2.2%) ÷ (8.9%– 2.2%) = CA$109b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$109b÷ ( 1 + 8.9%)10= CA$47b
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$77b. 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$61.7, the company appears about fair value at a 17% 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
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 TC Energy 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 8.9%, which is based on a levered beta of 1.619. 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 TC Energy
- Earnings growth over the past year exceeded the industry.
- Dividend is in the top 25% of dividend payers in the market.
- Interest payments on debt are not well covered.
- Annual earnings are forecast to grow for the next 3 years.
- Current share price is below our estimate of fair value.
- Debt is not well covered by operating cash flow.
- Dividends are not covered by earnings and cashflows.
- Annual earnings are forecast to grow slower than the Canadian market.
Moving On:
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. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For TC Energy, we've put together three essential aspects you should consider:
- Risks: For example, we've discovered 2 warning signs for TC Energy that you should be aware of before investing here.
- Future Earnings: How does TRP'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.
- 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 here to simplify it.
Discover if TC Energy might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
About TSX:TRP
Proven track record average dividend payer.