Calculating The Intrinsic Value Of Kestrel Gold Inc. (CVE:KGC)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Kestrel Gold fair value estimate is CA$0.06
• Current share price of CA$0.06 suggests Kestrel Gold is potentially trading close to its fair value
• Industry average of 41% suggests Kestrel Gold's peers are currently trading at a higher premium to fair value

In this article we are going to estimate the intrinsic value of Kestrel Gold Inc. (CVE:KGC) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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The Method

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CA$, Millions)	CA$79.8k	CA$116.9k	CA$155.8k	CA$193.3k	CA$227.3k	CA$257.2k	CA$282.8k	CA$304.8k	CA$323.7k	CA$340.3k
Growth Rate Estimate Source	Est @ 65.22%	Est @ 46.44%	Est @ 33.28%	Est @ 24.08%	Est @ 17.64%	Est @ 13.12%	Est @ 9.97%	Est @ 7.76%	Est @ 6.21%	Est @ 5.13%
Present Value (CA$, Millions) Discounted @ 6.4%	CA$0.07	CA$0.1	CA$0.1	CA$0.2	CA$0.2	CA$0.2	CA$0.2	CA$0.2	CA$0.2	CA$0.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$1.5m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.4%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CA$340k× (1 + 2.6%) ÷ (6.4%– 2.6%) = CA$9.1m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$9.1m÷ ( 1 + 6.4%)¹⁰= CA$4.9m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CA$6.4m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$0.06, 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.

Important 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 Kestrel Gold 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 6.4%, which is based on a levered beta of 0.912. 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.

See our latest analysis for Kestrel Gold

SWOT Analysis for Kestrel Gold

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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 Kestrel Gold, we've put together three additional items you should explore:

1. Risks: Take risks, for example - Kestrel Gold has 3 warning signs we think you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for KGC's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other High Quality Alternatives: Do you like a good all-rounder? 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 valuation for every stock on the TSXV 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.