Badger Daylighting Ltd (TSE:BAD) Is Trading At A 33.11% Discount To Its Intrinsic Value
March 6, 2018
I’m 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 perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF (CA$, Millions)||CA$55.15||CA$68.25||CA$75.03||CA$82.48||CA$90.68|
|Source||Analyst x2||Analyst x2||Extrapolated @ (9.93%)||Extrapolated @ (9.93%)||Extrapolated @ (9.93%)|
|Present Value Discounted @ 8.43%||CA$50.86||CA$58.05||CA$58.86||CA$59.68||CA$60.51|
Present Value of 5-year Cash Flow (PVCF)= CA$288
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 the GDP. In this case I have used the 10-year government bond rate (2.1%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.4%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CA$91 × (1 + 2.1%) ÷ (8.4% – 2.1%) = CA$1,471
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CA$1,471 / ( 1 + 8.4%)5 = CA$982
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is CA$1,270. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of CA$34.22, which, compared to the current share price of CA$22.89, we find that Badger Daylighting is quite good value at a 33.11% discount to what it is available for right now.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Badger Daylighting as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.4%, which is based on a levered beta of 0.8. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For BAD, there are three pertinent factors you should look at:
- Financial Health: Does BAD have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does BAD’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of BAD? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the TSX every 6 hours. If you want to find the calculation for other stocks just search here.