Estimating The Fair Value Of Orogen Royalties Inc. (CVE:OGN)

Key Insights

• The projected fair value for Orogen Royalties is CA$0.58 based on 2 Stage Free Cash Flow to Equity
• With CA$0.56 share price, Orogen Royalties appears to be trading close to its estimated fair value
• The average premium for Orogen Royalties' competitorsis currently 19%

Does the July share price for Orogen Royalties Inc. (CVE:OGN) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. 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 Orogen Royalties

The Model

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. 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$2.46m	CA$3.61m	CA$4.81m	CA$5.96m	CA$6.99m	CA$7.87m	CA$8.60m	CA$9.21m	CA$9.72m	CA$10.1m
Growth Rate Estimate Source	Est @ 66.01%	Est @ 46.75%	Est @ 33.27%	Est @ 23.83%	Est @ 17.22%	Est @ 12.59%	Est @ 9.35%	Est @ 7.09%	Est @ 5.50%	Est @ 4.39%
Present Value (CA$, Millions) Discounted @ 8.4%	CA$2.3	CA$3.1	CA$3.8	CA$4.3	CA$4.7	CA$4.9	CA$4.9	CA$4.8	CA$4.7	CA$4.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$42m

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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$10m× (1 + 1.8%) ÷ (8.4%– 1.8%) = CA$157m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$157m÷ ( 1 + 8.4%)¹⁰= CA$70m

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$112m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$0.6, the company appears about fair value at a 3.5% 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Orogen Royalties 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 8.4%, which is based on a levered beta of 1.109. 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 Orogen Royalties

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Orogen Royalties, we've compiled three fundamental items you should further research:

1. Risks: We feel that you should assess the 3 warning signs for Orogen Royalties we've flagged before making an investment in the company.
2. Future Earnings: How does OGN'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: 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.