Is there an opportunity with the 49% undervaluation of Rogers Communications Inc. (TSE: RCI.B)?
Does Rogers Communications Inc. (TSE: RCI.B)’s March share price reflect what it’s really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to the present value. Our analysis will use the discounted cash flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
See our latest analysis for Rogers Communications
Step by step in the calculation
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (CA$, Millions)||1.95 billion Canadian dollars||2.23 billion Canadian dollars||2.35 billion Canadian dollars||2.89 billion Canadian dollars||2.72 billion Canadian dollars||2.62 billion Canadian dollars||2.57 billion Canadian dollars||2.54 billion Canadian dollars||2.54 billion Canadian dollars||2.55 billion Canadian dollars|
|Growth rate estimate Source||Analyst x9||Analyst x9||Analyst x1||Analyst x1||Analyst x1||Is @ -3.58%||East @ -2.03%||East @ -0.96%||Is @ -0.2%||Is at 0.33%|
|Present value (CA$, millions) discounted at 5.0%||CA$1.9k||CA$2,000||CA$2,000||CA$2.4k||CA$2.1k||CA$2,000||CA$1.8k||CA$1.7k||CA$1.6k||CA$1.6k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = 19 billion Canadian dollars
After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.6%. We discount terminal cash flows to present value at a cost of equity of 5.0%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = C$2.5 billion × (1 + 1.6%) ÷ (5.0%–1.6%) = C$76 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= C$76B÷ ( 1 + 5.0%)ten= 47 billion Canadian dollars
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is C$66 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of C$67.3, the company looks quite undervalued at a 49% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Rogers Communications as a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation, we used 5.0%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is intrinsic value higher than the current stock price? For Rogers Communications, we’ve put together three relevant things you should consider:
- Risks: Every business has them, and we’ve spotted 1 warning sign for Rogers Communications you should know.
- Future earnings: How does RCI.B’s growth rate compare to its peers and the broader market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Canadian stock daily, so if you want to find the intrinsic value of any other stock, do a search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.