Are The Descartes Systems Group Inc. (TSE:DSG) Investors Paying Above The Intrinsic Value?
Key Insights
- The projected fair value for Descartes Systems Group is CA$85.47 based on 2 Stage Free Cash Flow to Equity
- Current share price of CA$104 suggests Descartes Systems Group is potentially 21% overvalued
- The US$97.88 analyst price target for DSG is 15% more than our estimate of fair value
In this article we are going to estimate the intrinsic value of The Descartes Systems Group Inc. (TSE:DSG) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for Descartes Systems Group
Crunching The Numbers
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$173.6m | US$204.3m | US$233.6m | US$265.0m | US$300.0m | US$340.0m | US$369.2m | US$393.4m | US$413.6m | US$430.7m |
Growth Rate Estimate Source | Analyst x5 | Analyst x6 | Analyst x6 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 8.59% | Est @ 6.56% | Est @ 5.13% | Est @ 4.13% |
Present Value ($, Millions) Discounted @ 7.7% | US$161 | US$176 | US$187 | US$197 | US$207 | US$218 | US$219 | US$217 | US$212 | US$205 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.0b
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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$431m× (1 + 1.8%) ÷ (7.7%– 1.8%) = US$7.4b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$7.4b÷ ( 1 + 7.7%)10= US$3.5b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$5.5b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$104, the company appears slightly overvalued 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
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 Descartes Systems 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 7.7%, which is based on a levered beta of 0.998. 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 Descartes Systems Group
- Earnings growth over the past year exceeded the industry.
- Currently debt free.
- Earnings growth over the past year is below its 5-year average.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow faster than the Canadian market.
- Revenue is forecast to grow slower than 20% per year.
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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 Descartes Systems Group, there are three relevant elements you should further research:
- Financial Health: Does DSG 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 DSG'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: 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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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About TSX:DSG
Descartes Systems Group
Provides cloud-based logistics and supply chain management solutions worldwide.
Flawless balance sheet with acceptable track record.