What’s the value?
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 five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF ($, Millions)||$0.39||$188.37||$309.91||$487.00||$481.00|
|Source||Analyst x4||Analyst x3||Analyst x2||Analyst x1||Analyst x1|
|Present Value Discounted @ 17.87%||$0.33||$135.59||$189.24||$252.30||$211.41|
Present Value of 5-year Cash Flow (PVCF)= $789
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.1%. We discount this to today’s value at a cost of equity of 17.9%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = $481 × (1 + 2.1%) ÷ (17.9% – 2.1%) = $3,121
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = $3,121 / ( 1 + 17.9%)5 = $1,372
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is CA$2,161. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of CA$25.97, which, compared to the current share price of CA$24.53, we find that Endeavour Mining is about right, perhaps slightly undervalued at a 5.55% discount to what it is available for right now.
I’d like to point out that 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Endeavour Mining as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 17.9%, which is based on a levered beta of 2. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. For EDV, there are three important aspects you should further research:
- Financial Health: Does EDV have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does EDV’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: Are there other high quality stocks you could be holding instead of EDV? 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 for every stock on the TSX every 6 hours. If you want to find the calculation for other stocks just search here.