A Look At The Fair Value Of Fortuna Silver Mines Inc. (TSE:FVI)

Key Insights

• The projected fair value for Fortuna Silver Mines is CA$4.82 based on 2 Stage Free Cash Flow to Equity
• Current share price of CA$4.96 suggests Fortuna Silver Mines is potentially trading close to its fair value
• Our fair value estimate is 17% lower than Fortuna Silver Mines' analyst price target of US$5.83

In this article we are going to estimate the intrinsic value of Fortuna Silver Mines Inc. (TSE:FVI) by taking the expected future cash flows and discounting them 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Fortuna Silver Mines

What's The Estimated Valuation?

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 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$197.0m	US$107.8m	US$108.0m	US$84.2m	US$71.6m	US$64.6m	US$60.5m	US$58.2m	US$57.0m	US$56.5m
Growth Rate Estimate Source	Analyst x2	Analyst x3	Analyst x1	Est @ -22.07%	Est @ -14.87%	Est @ -9.83%	Est @ -6.30%	Est @ -3.83%	Est @ -2.10%	Est @ -0.89%
Present Value ($, Millions) Discounted @ 7.9%	US$183	US$92.6	US$86.0	US$62.1	US$49.0	US$41.0	US$35.6	US$31.7	US$28.8	US$26.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$636m

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 7.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$56m× (1 + 1.9%) ÷ (7.9%– 1.9%) = US$966m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$966m÷ ( 1 + 7.9%)¹⁰= US$452m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$1.1b. 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$5.0, the company appears around fair value at the time of writing. 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.

The 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 Fortuna Silver Mines 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 7.9%, which is based on a levered beta of 1.192. 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 Fortuna Silver Mines

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 Fortuna Silver Mines, there are three additional factors you should assess:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Fortuna Silver Mines , and understanding these should be part of your investment process.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for FVI's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.