Smart Sand, Inc.'s (NASDAQ:SND) Intrinsic Value Is Potentially 42% Above Its Share Price

Key Insights

• Smart Sand's estimated fair value is US$3.11 based on 2 Stage Free Cash Flow to Equity
• Smart Sand is estimated to be 30% undervalued based on current share price of US$2.19
• Industry average discount to fair value of 16% suggests Smart Sand's peers are currently trading at a lower discount

Today we will run through one way of estimating the intrinsic value of Smart Sand, Inc. (NASDAQ:SND) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Smart Sand

The Method

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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$15.6m	US$13.6m	US$12.4m	US$11.8m	US$11.4m	US$11.3m	US$11.2m	US$11.3m	US$11.4m	US$11.5m
Growth Rate Estimate Source	Est @ -19.61%	Est @ -13.06%	Est @ -8.48%	Est @ -5.27%	Est @ -3.02%	Est @ -1.45%	Est @ -0.35%	Est @ 0.42%	Est @ 0.96%	Est @ 1.34%
Present Value ($, Millions) Discounted @ 10%	US$14.2	US$11.1	US$9.2	US$7.9	US$7.0	US$6.2	US$5.6	US$5.1	US$4.7	US$4.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$75m

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 5-year average of the 10-year government bond yield (2.2%) 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 10%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$12m× (1 + 2.2%) ÷ (10%– 2.2%) = US$144m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$144m÷ ( 1 + 10%)¹⁰= US$53m

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$129m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$2.2, the company appears a touch undervalued at a 30% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Smart Sand 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 10%, which is based on a levered beta of 1.640. 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.

Moving On:

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 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 Smart Sand, we've compiled three pertinent aspects you should consider:

1. Risks: Be aware that Smart Sand is showing 4 warning signs in our investment analysis , and 1 of those is a bit concerning...
2. Future Earnings: How does SND'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS 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.