A Look At The Intrinsic Value Of Aurora Cannabis Inc. (TSE:ACB)

By
Simply Wall St
Published
November 12, 2021
TSX:ACB
Source: Shutterstock

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Aurora Cannabis Inc. (TSE:ACB) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 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.

View our latest analysis for Aurora Cannabis

The method

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (CA$, Millions) -CA$58.2m -CA$32.5m -CA$41.4m CA$16.2m CA$37.4m CA$56.7m CA$77.5m CA$97.7m CA$115.9m CA$131.6m
Growth Rate Estimate Source Analyst x8 Analyst x7 Analyst x4 Analyst x1 Analyst x1 Est @ 51.53% Est @ 36.54% Est @ 26.04% Est @ 18.69% Est @ 13.55%
Present Value (CA$, Millions) Discounted @ 5.1% -CA$55.4 -CA$29.5 -CA$35.7 CA$13.3 CA$29.3 CA$42.2 CA$54.9 CA$65.8 CA$74.4 CA$80.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$239m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 (1.6%) 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 5.1%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CA$132m× (1 + 1.6%) ÷ (5.1%– 1.6%) = CA$3.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$3.8b÷ ( 1 + 5.1%)10= CA$2.3b

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$2.6b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$10.7, the company appears about fair value at a 17% 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.

dcf
TSX:ACB Discounted Cash Flow November 13th 2021

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 Aurora Cannabis 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 5.1%, which is based on a levered beta of 0.800. 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.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Aurora Cannabis, there are three further factors you should explore:

  1. Risks: To that end, you should be aware of the 3 warning signs we've spotted with Aurora Cannabis .
  2. Future Earnings: How does ACB'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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