Is East Side Games Group Inc. (TSE:EAGR) Worth CA$0.4 Based On Its Intrinsic Value?

Key Insights

• The projected fair value for East Side Games Group is CA$0.29 based on 2 Stage Free Cash Flow to Equity
• East Side Games Group is estimated to be 34% overvalued based on current share price of CA$0.39
• Analyst price target for EAGR is CA$2.30, which is 689% above our fair value estimate

Does the November share price for East Side Games Group Inc. (TSE:EAGR) 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. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

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.

Check out our latest analysis for East Side Games Group

The Model

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 start off with, we need to estimate 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, 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$1.64m	CA$1.49m	CA$1.41m	CA$1.36m	CA$1.34m	CA$1.33m	CA$1.33m	CA$1.34m	CA$1.35m	CA$1.37m
Growth Rate Estimate Source	Est @ -13.45%	Est @ -8.84%	Est @ -5.61%	Est @ -3.35%	Est @ -1.76%	Est @ -0.65%	Est @ 0.12%	Est @ 0.66%	Est @ 1.04%	Est @ 1.31%
Present Value (CA$, Millions) Discounted @ 7.0%	CA$1.5	CA$1.3	CA$1.1	CA$1.0	CA$1.0	CA$0.9	CA$0.8	CA$0.8	CA$0.7	CA$0.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$9.9m

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 (1.9%) 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 7.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$1.4m× (1 + 1.9%) ÷ (7.0%– 1.9%) = CA$27m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$27m÷ ( 1 + 7.0%)¹⁰= CA$14m

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$24m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$0.4, the company appears reasonably expensive at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The 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. 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 East Side Games Group 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 7.0%, which is based on a levered beta of 1.019. 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.

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. What is the reason for the share price exceeding the intrinsic value? For East Side Games Group, we've compiled three essential items you should further research:

1. Risks: Case in point, we've spotted 2 warning signs for East Side Games Group you should be aware of.
2. Future Earnings: How does EAGR'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. 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.