Estimating The Intrinsic Value Of Queen's Road Capital Investment Ltd. (TSE:QRC)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Queen's Road Capital Investment fair value estimate is CA$0.81
• With CA$0.80 share price, Queen's Road Capital Investment appears to be trading close to its estimated fair value
• Peers of Queen's Road Capital Investment are currently trading on average at a 10% premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Queen's Road Capital Investment Ltd. (TSE:QRC) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Queen's Road Capital Investment

Is Queen's Road Capital Investment 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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$5.95m	US$8.69m	US$11.5m	US$14.3m	US$16.7m	US$18.8m	US$20.5m	US$22.0m	US$23.2m	US$24.2m
Growth Rate Estimate Source	Est @ 64.86%	Est @ 45.98%	Est @ 32.77%	Est @ 23.52%	Est @ 17.04%	Est @ 12.51%	Est @ 9.33%	Est @ 7.11%	Est @ 5.56%	Est @ 4.47%
Present Value ($, Millions) Discounted @ 8.2%	US$5.5	US$7.4	US$9.1	US$10.4	US$11.2	US$11.7	US$11.8	US$11.7	US$11.4	US$11.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$101m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$24m× (1 + 1.9%) ÷ (8.2%– 1.9%) = US$391m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$391m÷ ( 1 + 8.2%)¹⁰= US$177m

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$278m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CA$0.8, the company appears about fair value at a 0.6% 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

We would point out that 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 Queen's Road Capital Investment 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 8.2%, which is based on a levered beta of 1.068. 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 Queen's Road Capital Investment

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. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Queen's Road Capital Investment, there are three pertinent elements you should further research:

1. Risks: Take risks, for example - Queen's Road Capital Investment has 1 warning sign we think you should be aware of.
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.