An Intrinsic Calculation For Atlas Engineered Products Ltd. (CVE:AEP) Suggests It's 46% Undervalued

Key Insights

• The projected fair value for Atlas Engineered Products is CA$1.91 based on 2 Stage Free Cash Flow to Equity
• Atlas Engineered Products is estimated to be 46% undervalued based on current share price of CA$1.03
• Atlas Engineered Products' peers are currently trading at a premium of 49% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Atlas Engineered Products Ltd. (CVE:AEP) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Atlas Engineered Products

Is Atlas Engineered Products 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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CA$, Millions)	CA$9.10m	CA$9.90m	CA$10.3m	CA$10.7m	CA$11.0m	CA$11.3m	CA$11.6m	CA$11.9m	CA$12.1m	CA$12.3m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 4.42%	Est @ 3.62%	Est @ 3.06%	Est @ 2.67%	Est @ 2.40%	Est @ 2.21%	Est @ 2.07%	Est @ 1.98%
Present Value (CA$, Millions) Discounted @ 11%	CA$8.2	CA$8.0	CA$7.6	CA$7.1	CA$6.5	CA$6.1	CA$5.6	CA$5.1	CA$4.7	CA$4.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$63m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.8%) 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 11%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CA$12m× (1 + 1.8%) ÷ (11%– 1.8%) = CA$136m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$136m÷ ( 1 + 11%)¹⁰= CA$48m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CA$111m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$1.0, the company appears quite good value at a 46% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Atlas Engineered Products 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 11%, which is based on a levered beta of 1.559. 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.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Atlas Engineered Products, we've compiled three important aspects you should look at:

1. Risks: Take risks, for example - Atlas Engineered Products has 2 warning signs (and 1 which is concerning) we think you should know about.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AEP'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSXV every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.