Is There An Opportunity With TerrAscend Corp.'s (CSE:TER) 37% Undervaluation?

Key Insights

• TerrAscend's estimated fair value is US$2.7 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$1.7 suggests TerrAscend is 37% undervalued
• Analyst price target for TER is US$4.35 which is 60% above our fair value estimate

How far off is TerrAscend Corp. (CSE:TER) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 TerrAscend

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. To start off with, we need to estimate 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.

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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	-US$865.0k	US$13.4m	US$19.3m	US$23.9m	US$28.0m	US$31.5m	US$34.4m	US$36.8m	US$38.8m	US$40.4m
Growth Rate Estimate Source	Analyst x7	Analyst x3	Analyst x2	Est @ 23.70%	Est @ 17.09%	Est @ 12.47%	Est @ 9.24%	Est @ 6.97%	Est @ 5.39%	Est @ 4.28%
Present Value ($, Millions) Discounted @ 6.2%	-US$0.8	US$11.9	US$16.1	US$18.8	US$20.7	US$21.9	US$22.5	US$22.7	US$22.5	US$22.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$178m

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 (1.7%) 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 6.2%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$40m× (1 + 1.7%) ÷ (6.2%– 1.7%) = US$903m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$903m÷ ( 1 + 6.2%)¹⁰= US$493m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$671m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$1.7, the company appears quite good value at a 37% 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 TerrAscend 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 6.2%, which is based on a levered beta of 0.818. 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 TerrAscend

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. Why is the intrinsic value higher than the current share price? For TerrAscend, we've compiled three important aspects you should assess:

1. Risks: As an example, we've found 3 warning signs for TerrAscend (1 doesn't sit too well with us!) that you need to consider before investing here.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for TER'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. 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.