An Intrinsic Calculation For Canadian Tire Corporation, Limited (TSE:CTC.A) Suggests It's 25% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Canadian Tire Corporation fair value estimate is CA$220
• Current share price of CA$166 suggests Canadian Tire Corporation is potentially 25% undervalued
• The CA$170 analyst price target for CTC.A is 23% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Canadian Tire Corporation, Limited (TSE:CTC.A) 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. It may sound complicated, but actually it is quite simple!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Our free stock report includes 2 warning signs investors should be aware of before investing in Canadian Tire Corporation. Read for free now.

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 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CA$, Millions)	CA$388.0m	CA$562.3m	CA$809.0m	CA$771.0m	CA$927.0m	CA$1.02b	CA$1.10b	CA$1.17b	CA$1.23b	CA$1.29b
Growth Rate Estimate Source	Analyst x2	Analyst x3	Analyst x1	Analyst x1	Analyst x1	Est @ 10.33%	Est @ 7.94%	Est @ 6.27%	Est @ 5.10%	Est @ 4.27%
Present Value (CA$, Millions) Discounted @ 9.9%	CA$353	CA$466	CA$610	CA$529	CA$579	CA$582	CA$572	CA$553	CA$529	CA$502

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$5.3b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.4%) 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 9.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CA$1.3b× (1 + 2.4%) ÷ (9.9%– 2.4%) = CA$18b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$18b÷ ( 1 + 9.9%)¹⁰= CA$6.9b

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$12b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$166, the company appears a touch undervalued at a 25% 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Canadian Tire Corporation 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 9.9%, which is based on a levered beta of 1.730. 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.

Check out our latest analysis for Canadian Tire Corporation

SWOT Analysis for Canadian Tire Corporation

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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. Why is the intrinsic value higher than the current share price? For Canadian Tire Corporation, we've compiled three important aspects you should assess:

1. Risks: Every company has them, and we've spotted 2 warning signs for Canadian Tire Corporation (of which 1 is concerning!) you should know about.
2. Future Earnings: How does CTC.A'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.