Stock Analysis

# Calculating The Fair Value Of Tecsys Inc. (TSE:TCS)

### Key Insights

• Tecsys' estimated fair value is CA\$34.29 based on 2 Stage Free Cash Flow to Equity
• With CA\$33.78 share price, Tecsys appears to be trading close to its estimated fair value
• The CA\$46.40 analyst price target for TCS is 35% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Tecsys Inc. (TSE:TCS) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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

## Step By Step Through The Calculation

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

#### 10-year free cash flow (FCF) estimate

 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (CA\$, Millions) CA\$2.85m CA\$12.3m CA\$16.2m CA\$19.8m CA\$23.1m CA\$25.9m CA\$28.2m CA\$30.2m CA\$31.8m CA\$33.2m Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ 31.51% Est @ 22.64% Est @ 16.42% Est @ 12.08% Est @ 9.03% Est @ 6.90% Est @ 5.41% Est @ 4.37% Present Value (CA\$, Millions) Discounted @ 6.8% CA\$2.7 CA\$10.8 CA\$13.3 CA\$15.2 CA\$16.6 CA\$17.4 CA\$17.8 CA\$17.8 CA\$17.6 CA\$17.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA\$146m

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 (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 6.8%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA\$33m× (1 + 1.9%) ÷ (6.8%– 1.9%) = CA\$693m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA\$693m÷ ( 1 + 6.8%)10= CA\$358m

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 CA\$505m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA\$33.8, the company appears about fair value at a 1.5% 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.

## Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Tecsys 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 6.8%, which is based on a levered beta of 0.977. 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 Tecsys

Strength
• Currently debt free.
Weakness
• Earnings declined over the past year.
• Dividend is low compared to the top 25% of dividend payers in the Software market.
Opportunity
• Annual revenue is forecast to grow faster than the Canadian market.
• Current share price is below our estimate of fair value.
Threat
• Revenue is forecast to grow slower than 20% per year.

## Next Steps:

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. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Tecsys, we've compiled three fundamental aspects you should assess:

1. Risks: Case in point, we've spotted 2 warning signs for Tecsys you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for TCS's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.

### Valuation is complex, but we're helping make it simple.

Find out whether Tecsys is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.