Estimating The Intrinsic Value Of CGI Inc. (TSE:GIB.A)

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Today we will run through one way of estimating the intrinsic value of CGI Inc. (TSE:GIB.A) by taking the expected future cash flows and discounting them to today’s value. I will use the Discounted Cash Flow (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. 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.

Check out our latest analysis for CGI

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. 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 are 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

2019 2020 2021 2022 2023 2024 2025 2026 2027 2028
Levered FCF (CA$, Millions) CA$1.45k CA$1.51k CA$1.57k CA$1.62k CA$1.67k CA$1.71k CA$1.75k CA$1.79k CA$1.83k CA$1.87k
Growth Rate Estimate Source Analyst x8 Analyst x8 Est @ 3.76% Est @ 3.22% Est @ 2.84% Est @ 2.57% Est @ 2.38% Est @ 2.25% Est @ 2.16% Est @ 2.1%
Present Value (CA$, Millions) Discounted @ 6.72% CA$1.36k CA$1.33k CA$1.29k CA$1.25k CA$1.21k CA$1.16k CA$1.11k CA$1.06k CA$1.02k CA$975.34

Present Value of 10-year Cash Flow (PVCF)= CA$11.76b

“Est” = FCF growth rate estimated by Simply Wall St

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 10-year government bond rate (1.9%) 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 6.7%.

Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = CA$1.9b × (1 + 1.9%) ÷ (6.7% – 1.9%) = CA$40b

Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = CA$CA$40b ÷ ( 1 + 6.7%)10 = CA$20.85b

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$32.62b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value estimate of CA$119.37. Relative to the current share price of CA$95.74, the company appears about fair value at a 20% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

TSX:GIB.A Intrinsic value, April 30th 2019
TSX:GIB.A Intrinsic value, April 30th 2019

Important 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. 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 CGI 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 6.7%, 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:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching 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?” 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. For CGI, I’ve compiled three relevant factors you should further research:

  1. Financial Health: Does GIB.A 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.
  2. Future Earnings: How does GIB.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: Are there other high quality stocks you could be holding instead of GIB.A? 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 valuation for every stock on the TSE every day. If you want to find the calculation for other stocks just search here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.