An Intrinsic Calculation For Worksport Ltd. (NASDAQ:WKSP) Suggests It's 45% Undervalued

Does the February share price for Worksport Ltd. (NASDAQ:WKSP) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Worksport

What's the estimated valuation?

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. To start off with, we need to estimate 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF ($, Millions)	US$350.0k	US$1.06m	US$1.75m	US$2.57m	US$3.42m	US$4.23m	US$4.95m	US$5.58m	US$6.10m	US$6.54m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 65.47%	Est @ 46.41%	Est @ 33.06%	Est @ 23.72%	Est @ 17.18%	Est @ 12.6%	Est @ 9.4%	Est @ 7.15%
Present Value ($, Millions) Discounted @ 7.5%	US$0.3	US$0.9	US$1.4	US$1.9	US$2.4	US$2.7	US$3.0	US$3.1	US$3.2	US$3.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$22m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = US$6.5m× (1 + 1.9%) ÷ (7.5%– 1.9%) = US$120m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$120m÷ ( 1 + 7.5%)¹⁰= US$58m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$80m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$2.6, the company appears quite good value at a 45% 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.

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 Worksport 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 7.5%, which is based on a levered beta of 1.310. 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:

Although the valuation of a company is important, it 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Worksport, we've compiled three additional items you should further research:

1. Risks: For example, we've discovered 4 warning signs for Worksport (2 are significant!) that you should be aware of before investing here.
2. Future Earnings: How does WKSP'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQCM every day. If you want to find the calculation for other stocks 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.