Does the October share price for Exchange Income Corporation (TSE:EIF) reflect what it’s really worth? Today, we will estimate the stock’s intrinsic value by estimating the company’s future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There’s really not all that much to it, even though it might appear quite complex.
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.
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.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
|Levered FCF (CA$, Millions)||CA$157.0m||CA$140.3m||CA$130.8m||CA$125.3m||CA$122.3m||CA$120.8m||CA$120.3m||CA$120.6m||CA$121.4m||CA$122.6m|
|Growth Rate Estimate Source||Analyst x4||Analyst x2||Est @ -6.73%||Est @ -4.22%||Est @ -2.45%||Est @ -1.22%||Est @ -0.36%||Est @ 0.25%||Est @ 0.67%||Est @ 0.97%|
|Present Value (CA$, Millions) Discounted @ 9.4%||CA$143||CA$117||CA$99.9||CA$87.5||CA$78.0||CA$70.4||CA$64.1||CA$58.7||CA$54.1||CA$49.9|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$823m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (1.7%) 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 9.4%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = CA$123m× (1 + 1.7%) ÷ (9.4%– 1.7%) = CA$1.6b
Present Value of…
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