Estimating The Fair 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$0.051
• Kestrel Gold's CA$0.055 share price indicates it is trading at similar levels as its fair value estimate
• Industry average of 38% 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 taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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Step By Step Through The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

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

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CA$, Millions)	CA$79.8k	CA$117.0k	CA$156.0k	CA$193.7k	CA$228.1k	CA$258.4k	CA$284.5k	CA$307.0k	CA$326.5k	CA$343.7k
Growth Rate Estimate Source	Est @ 65.27%	Est @ 46.51%	Est @ 33.38%	Est @ 24.19%	Est @ 17.76%	Est @ 13.26%	Est @ 10.11%	Est @ 7.90%	Est @ 6.35%	Est @ 5.27%
Present Value (CA$, Millions) Discounted @ 7.1%	CA$0.07	CA$0.1	CA$0.1	CA$0.1	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

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 (2.8%) 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 7.1%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CA$344k× (1 + 2.8%) ÷ (7.1%– 2.8%) = CA$8.0m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$8.0m÷ ( 1 + 7.1%)¹⁰= CA$4.0m

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$5.5m. 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$0.06, the company appears around fair value at the time of writing. 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 7.1%, which is based on a levered beta of 1.043. 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

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. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Kestrel Gold, we've put together three further aspects you should further research:

1. Risks: For example, we've discovered 2 warning signs for Kestrel Gold that you should be aware of before investing here.
2. 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!
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 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.