Estimating The Intrinsic Value Of Lundin Gold Inc (TSE:LUG)

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Lundin Gold Inc (TSE:LUG) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in November 2018 so be sure check out the updated calculation by following the link below.

Check out our latest analysis for Lundin Gold

The method

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow estimate

2019 2020 2021 2022 2023
Levered FCF ($, Millions) $-372.69 $110.54 $173.64 $186.48 $200.26
Source Analyst x6 Analyst x2 Analyst x1 Est @ 7.39% Est @ 7.39%
Present Value Discounted @ 17.66% $-316.76 $79.85 $106.60 $97.30 $88.81

Present Value of 5-year Cash Flow (PVCF)= US$56m

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.3%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 17.7%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$200m × (1 + 2.3%) ÷ (17.7% – 2.3%) = US$1.3b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$1.3b ÷ ( 1 + 17.7%)5 = US$593m

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$649m. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value in the company’s reported currency of $3.04. However, LUG’s primary listing is in Canada, and 1 share of LUG in USD represents 1.312 ( USD/ CAD) share of TSX:LUG, so the intrinsic value per share in CAD is CA$3.99. Compared to the current share price of CA$4.66, the stock is fair value, maybe slightly overvalued at the time of writing.

TSX:LUG Intrinsic Value Export November 9th 18
TSX:LUG Intrinsic Value Export November 9th 18

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Lundin Gold 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 17.7%, 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.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For LUG, I’ve compiled three pertinent factors you should further examine:

  1. Financial Health: Does LUG 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.
  2. Future Earnings: How does LUG’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: Are there other high quality stocks you could be holding instead of LUG? 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 TSE every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.