A Look At The Fair Value Of Cineplex Inc. (TSE:CGX)

Key Insights

• Cineplex's estimated fair value is CA$10.06 based on 2 Stage Free Cash Flow to Equity
• Current share price of CA$8.77 suggests Cineplex is potentially trading close to its fair value
• Our fair value estimate is 20% lower than Cineplex's analyst price target of CA$12.63

How far off is Cineplex Inc. (TSE:CGX) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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

View our latest analysis for Cineplex

Crunching The Numbers

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. 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 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 (CA$, Millions)	CA$100.7m	CA$84.0m	CA$74.7m	CA$69.3m	CA$66.1m	CA$64.4m	CA$63.6m	CA$63.4m	CA$63.6m	CA$64.1m
Growth Rate Estimate Source	Analyst x4	Analyst x1	Est @ -11.12%	Est @ -7.23%	Est @ -4.50%	Est @ -2.59%	Est @ -1.26%	Est @ -0.32%	Est @ 0.33%	Est @ 0.79%
Present Value (CA$, Millions) Discounted @ 12%	CA$90.1	CA$67.1	CA$53.3	CA$44.2	CA$37.8	CA$32.9	CA$29.0	CA$25.9	CA$23.2	CA$20.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$424m

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 12%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$64m× (1 + 1.9%) ÷ (12%– 1.9%) = CA$653m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$653m÷ ( 1 + 12%)¹⁰= CA$213m

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$637m. 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$8.8, the company appears about fair value at a 13% 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

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 Cineplex 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 12%, which is based on a levered beta of 2.000. 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 Cineplex

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. 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?" 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 Cineplex, we've put together three further elements you should further research:

1. Risks: To that end, you should learn about the 3 warning signs we've spotted with Cineplex (including 2 which make us uncomfortable) .
2. Future Earnings: How does CGX'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 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. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of any other stock 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.