Ascot Resources Ltd. (TSE:AOT) Shares Could Be 46% Below Their Intrinsic Value Estimate

Key Insights

• The projected fair value for Ascot Resources is CA$0.91 based on 2 Stage Free Cash Flow to Equity
• Ascot Resources' CA$0.49 share price signals that it might be 46% undervalued

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Ascot Resources Ltd. (TSE:AOT) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Ascot Resources

Is Ascot Resources Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$14.5m	CA$18.7m	CA$22.6m	CA$26.0m	CA$28.9m	CA$31.3m	CA$33.3m	CA$35.0m	CA$36.5m	CA$37.7m
Growth Rate Estimate Source	Analyst x2	Est @ 28.84%	Est @ 20.75%	Est @ 15.08%	Est @ 11.11%	Est @ 8.34%	Est @ 6.39%	Est @ 5.03%	Est @ 4.08%	Est @ 3.42%
Present Value (CA$, Millions) Discounted @ 7.6%	CA$13.5	CA$16.2	CA$18.2	CA$19.4	CA$20.1	CA$20.2	CA$20.0	CA$19.5	CA$18.9	CA$18.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$184m

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 (1.9%) 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 7.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$38m× (1 + 1.9%) ÷ (7.6%– 1.9%) = CA$671m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$671m÷ ( 1 + 7.6%)¹⁰= CA$323m

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$507m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$0.5, the company appears quite undervalued at a 46% 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 Ascot Resources 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 7.6%, which is based on a levered beta of 1.145. 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 Ascot Resources

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Ascot Resources, there are three pertinent factors you should explore:

1. Risks: For example, we've discovered 3 warning signs for Ascot Resources (2 are potentially serious!) that you should be aware of before investing here.
2. Future Earnings: How does AOT'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. 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.