In this article I am going to calculate the intrinsic value of AutoCanada Inc (TSE:ACQ) by projecting its future cash flows and then discounting them to today’s value. This is done using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for AutoCanada by following the link below.
I’m 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 perpetual stable growth rate. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
|Levered FCF (CA$, Millions)||CA$48.87||CA$58.63||CA$67.92||CA$78.68||CA$91.14|
|Source||Analyst x4||Analyst x1||Est @ 15.84%||Est @ 15.84%||Est @ 15.84%|
|Present Value Discounted @ 17.66%||CA$41.54||CA$42.35||CA$41.70||CA$41.05||CA$40.42|
Present Value of 5-year Cash Flow (PVCF)= CA$207m
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.3%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 17.7%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CA$91m × (1 + 2.3%) ÷ (17.7% – 2.3%) = CA$609m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CA$609m ÷ ( 1 + 17.7%)5 = CA$270m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CA$477m. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of CA$17.42. Relative to the current share price of CA$10.05, the stock is quite good value at a 42% discount to what it is available for right now.
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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at AutoCanada as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 17.7%, which is based on a levered beta of 2. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For ACQ, I’ve put together three relevant factors you should further research:
- Financial Health: Does ACQ have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does ACQ’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of ACQ? 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 for every stock on the TSE every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.