How far off is Pilbara Minerals Limited (ASX
LS) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
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. For those who are keen learners of equity analysis, theSimply Wall St analysis model heremay be something of interest to you.
Check out our latest analysis for Pilbara Minerals
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. 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 discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
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| 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 |
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| 1 | Levered FCF (A$, Millions) | AU$2.42b | AU$1.50b | AU$1.20b | AU$1.72b | AU$1.30b | AU$1.30b | AU$1.31b | AU$1.32b | AU$1.34b | AU$1.36b |
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| 2 | Growth Rate Estimate Source | Analyst x6 | Analyst x6 | Analyst x6 | Analyst x4 | Analyst x3 | Est @ 0.11% | Est @ 0.66% | Est @ 1.04% | Est @ 1.31% | Est @ 1.49% |
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| 3 | Present Value (A$, Millions) Discounted @ 8.5% | AU$2.2k | AU$1.3k | AU$937 | AU$1.2k | AU$861 | AU$794 | AU$736 | AU$685 | AU$640 | AU$598 |
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("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF)= AU$10.0b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 8.5%.
Terminal Value (TV)= FCF2032× (1 + g) ÷ (r – g) = AU$1.4b× (1 + 1.9%) ÷ (8.5%– 1.9%) = AU$21b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$21b÷ ( 1 + 8.5%)10= AU$9.2b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$19b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$4.9, the company appears a touch undervalued at a 24% 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
you can read the rest of the report in the above tweet , Copy and paste .
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