Calculating The Fair Value Of Canacol Energy Ltd (TSE: CNE)

0

In this article we are going to estimate the intrinsic value of Canacol Energy Ltd (TSE: CNE) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won’t be able to understand it, just read on! It’s actually much less complex than you’d imagine.

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 Canacol Energy

What’s the estimated valuation?

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. 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) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US $ 19.6m US $ 26.0m US $ 30.8m US $ 35.0m US $ 38.4m US $ 41.2m US $ 43.6m US $ 45.5m US $ 47.1m US $ 48.5m
Growth Rate Estimate Source Analyst x3 Analyst x1 Est @ 18.52% Est @ 13.43% Est @ 9.87% Est @ 7.37% Est @ 5.63% East @ 4.4% Est @ 3.55% Est @ 2.95%
Present Value ($, Millions) Discounted @ 9.2% US $ 18.0 US $ 21.8 US $ 23.7 US $ 24.6 US $ 24.7 US $ 24.3 US $ 23.5 US $ 22.5 US $ 21.3 US $ 20.1

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US $ 224m

The 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 (1.6%) 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 9.2%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 48m × (1 + 1.6%) ÷ (9.2% – 1.6%) = US $ 642m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US $ 642m ÷ (1 + 9.2%)10= US $ 266m

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 $ 490m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA $ 3.5, the company appears around fair value at the time of writing. 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.

TSX: CNE Discounted Cash Flow November 6th 2021

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Canacol Energy 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 9.2%, which is based on a levered beta of 1.749. 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.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It’s not possible to obtain a foolproof valuation with a DCF model. Preferably you’d apply different cases and assumptions and see how they would impact the company’s valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Canacol Energy, we’ve compiled three further aspects you should explore:

  1. Risks: We feel that you should assess the 3 warning signs for Canacol Energy (1 is concerning!) We’ve flagged before making an investment in the company.
  2. Management: Have insiders been ramping up their shares to take advantage of the market’s sentiment for CNE’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSX every day. If you want to find the calculation for other stocks just search here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.


Source link

Leave A Reply

Your email address will not be published.