An Intrinsic Calculation For GURU Organic Energy Corp. (TSE:GURU) Suggests It's 49% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, GURU Organic Energy fair value estimate is CA$3.33
• Current share price of CA$1.71 suggests GURU Organic Energy is potentially 49% undervalued
• GURU Organic Energy's peers seem to be trading at a higher discount to fair value based onthe industry average of 50%

Does the January share price for GURU Organic Energy Corp. (TSE:GURU) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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.

See our latest analysis for GURU Organic Energy

Is GURU Organic Energy Fairly Valued?

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$5.58m	-CA$2.66m	CA$1.15m	CA$1.76m	CA$2.42m	CA$3.08m	CA$3.69m	CA$4.22m	CA$4.67m	CA$5.05m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 52.86%	Est @ 37.68%	Est @ 27.06%	Est @ 19.62%	Est @ 14.42%	Est @ 10.77%	Est @ 8.22%
Present Value (CA$, Millions) Discounted @ 5.6%	-CA$5.3	-CA$2.4	CA$1.0	CA$1.4	CA$1.8	CA$2.2	CA$2.5	CA$2.7	CA$2.9	CA$2.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$9.9m

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 5.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CA$5.1m× (1 + 2.3%) ÷ (5.6%– 2.3%) = CA$157m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$157m÷ ( 1 + 5.6%)¹⁰= CA$91m

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$101m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$1.7, the company appears quite undervalued at a 49% 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

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 GURU Organic 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 5.6%, which is based on a levered beta of 0.800. 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 GURU Organic Energy

Looking Ahead:

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. It's not possible to obtain a foolproof valuation with a DCF model. 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. What is the reason for the share price sitting below the intrinsic value? For GURU Organic Energy, we've compiled three further elements you should further examine:

1. Risks: Every company has them, and we've spotted 1 warning sign for GURU Organic Energy you should know about.
2. Future Earnings: How does GURU'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. 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.