Fortescue Metals Group Limited (ASX:FMG) Shares Could Be 31% Below Their Intrinsic Value Estimate
Does the July share price for Fortescue Metals Group Limited (ASX:FMG) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in theSimply Wall St analysis model.
View our latest analysis for Fortescue Metals Group
The method
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 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.
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
2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 1 Levered FCF ($, Millions) US$6.37b US$4.25b US$3.85b US$3.01b US$4.48b US$4.50b US$4.53b US$4.58b US$4.65b US$4.72b 2 Growth Rate Estimate Source Analyst x8 Analyst x7 Analyst x3 Analyst x2 Analyst x1 Est @ 0.32% Est @ 0.8% Est @ 1.14% Est @ 1.37% Est @ 1.54% 3 Present Value ($, Millions) Discounted @ 7.0% US$5.9k US$3.7k US$3.1k US$2.3k US$3.2k US$3.0k US$2.8k US$2.7k US$2.5k US$2.4k ("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF)= US$32bThe 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 7.0%.
Terminal Value (TV)= FCF2031× (1 + g) ÷ (r – g) = US$4.7b× (1 + 1.9%) ÷ (7.0%– 1.9%) = US$94b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$94b÷ ( 1 + 7.0%)10= US$48b
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$79b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$23.6, the company appears quite undervalued at a 31% 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.
ASX:FMG Discounted Cash Flow July 4th 2021
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$17.49 |
Change
0.300(1.75%) |
Mkt cap ! $53.85B |
Open | High | Low | Value | Volume |
$17.34 | $17.56 | $17.13 | $141.9M | 8.137M |
Buyers (Bids)
No. | Vol. | Price($) |
---|---|---|
1 | 286 | $17.45 |
Sellers (Offers)
Price($) | Vol. | No. |
---|---|---|
$17.49 | 26714 | 5 |
View Market Depth
No. | Vol. | Price($) |
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1 | 286 | 17.450 |
3 | 5306 | 17.400 |
3 | 99838 | 17.390 |
3 | 22791 | 17.350 |
1 | 2000 | 17.340 |
Price($) | Vol. | No. |
---|---|---|
17.490 | 26714 | 5 |
17.500 | 9903 | 6 |
17.510 | 27052 | 2 |
17.520 | 5923 | 2 |
17.540 | 21518 | 1 |
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