Estimating The Intrinsic Value Of Sigma Lithium Corporation (NASDAQ:SGML)

Key Insights

• Sigma Lithium's estimated fair value is US$28.40 based on 2 Stage Free Cash Flow to Equity
• Sigma Lithium's US$27.10 share price indicates it is trading at similar levels as its fair value estimate
• The CA$48.00 analyst price target for SGML is 69% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Sigma Lithium Corporation (NASDAQ:SGML) 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. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Sigma Lithium

What's The Estimated Valuation?

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 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$503.4m	CA$745.3m	CA$604.5m	CA$527.1m	CA$483.3m	CA$458.3m	CA$444.6m	CA$438.2m	CA$436.6m	CA$438.3m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x2	Est @ -12.80%	Est @ -8.32%	Est @ -5.18%	Est @ -2.98%	Est @ -1.44%	Est @ -0.36%	Est @ 0.39%
Present Value (CA$, Millions) Discounted @ 13%	CA$447	CA$588	CA$424	CA$328	CA$267	CA$225	CA$194	CA$170	CA$150	CA$134

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$2.9b

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 13%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$438m× (1 + 2.2%) ÷ (13%– 2.2%) = CA$4.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$4.3b÷ ( 1 + 13%)¹⁰= CA$1.3b

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$4.2b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$27.1, the company appears about fair value at a 4.6% 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

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. 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 Sigma Lithium 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 13%, which is based on a levered beta of 1.089. 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 Sigma Lithium

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. For Sigma Lithium, we've compiled three pertinent elements you should assess:

1. Risks: You should be aware of the 4 warning signs for Sigma Lithium (2 are a bit concerning!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does SGML'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.