Trican Well Service Ltd.'s (TSE:TCW) Intrinsic Value Is Potentially 25% Below Its Share Price
Today we're going to go through a way to see the intrinsic value of Trican Well Service Ltd. (TSE: TCW) by projecting future cash flows and then discounting them to today's value. We use the Discounted Cash Flow (DCF) model for this purpose. Models like this may seem beyond the understanding of a layperson, but are fairly easy to follow.
Remember, however, that there are many ways to appreciate a company's value, and a DCF is just one method. If you want to find out more about the intrinsic value, you should read the Simply Wall St analysis model.
Check out our latest analysis for Trican Well Service
We use the two-tier growth model, which simply means that we consider two stages in the company's growth. In the initial phase, the company can have a higher growth rate, and in the second phase, a stable growth rate is usually assumed. In the first phase, we need to estimate the cash flows for the business over the next ten years. We use analyst estimates whenever possible. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to reflect that growth tends to slow down more in the early years than in later years.
In general, we assume that a dollar today is more valuable than a dollar in the future. Hence, we need to discount the sum of these future cash flows to get a present value estimate:
10-year free cash flow forecast (FCF)
Leverage FCF (CA $, million)
CA $ 7.43 million
CA $ 22.8 million
CA $ 21.5 million
CA $ 20.7 million
CA $ 20.3 million
CA $ 20.1 million
CA $ 20.1 million
CA $ 20.2 million
CA $ 20.4 million
CA $ 20.6 million
Growth rate estimate source
Est @ -5.69%
Est @ -3.49%
Est @ -1.94%
Est @ -0.86%
Est @ -0.11%
Est @ 0.42%
Est @ 0.79%
Est @ 1.05%
Cash Value (CA $, Million) at a 9.3% discount
CA $ 6.8
CA $ 19.1
CA $ 16.5
CA $ 14.5
CA $ 13.0
CA $ 11.8
CA $ 10.8
CA $ 9.9
CA $ 9.2
CA $ 8.5
("Est" = FCF growth rate, estimated by Simply Wall St)
Present Value of 10 Year Cash Flow (PVCF) = CA $ 120 million
The second level is also known as Terminal Value. This is the company's cash flow after the first stage. The Gordon growth formula is used to calculate the terminal value using a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 9.3%.
End value (TV) = FCF2030 × (1 + g) ÷ (r - g) = CA $ 21 million × (1 + 1.7%) ÷ (9.3% - 1.7%) = CA $ 275 million .
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = CA $ 275 million ÷ (1 + 9.3%) 10 = CA $ 114 million
The total or equity value is then the sum of the present value of future cash flows, which in this case is CA $ 234 million. In the final step, we divide the equity value by the number of shares issued. Compared to its current share price of CA $ 1.2, the company may appear overvalued at the time of writing. However, remember that this is only an approximate rating, and like any complex formula - garbage in, garbage out.
The most important inputs for a discounted cash flow are now the discount rate and of course the actual cash flows. If you do not agree with this result, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclical nature of an industry or the future capital requirements of a company, so it does not give a complete picture of a company's potential performance. Given that we consider Trican Well Service to be 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) responsible for debt. In this calculation we used 9.3% based on a leverage beta of 1.263. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry-standard average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable business.
While evaluating a company is important, it is just one of many factors that you need to evaluate for a company. DCF models are not the be-all and end-all of investment valuation. Instead, the best use for a DCF model is to test certain assumptions and theories to determine whether they would result in the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk-free rate can significantly affect the valuation. Why is the intrinsic value lower than the current share price? For Trican Well Service, there are three other factors that you should investigate further:
Risks: Every business has them, and we've spotted two warning signs for Trican Well Service that you should be aware of.
Future Outcome: What is TCW's growth rate compared to its competitors and the broader market? Learn more about analyst consensus number for the years to come by interacting with our free analyst growth expectation chart.
Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else you might be missing!
PS. The Simply Wall St app performs a discounted cash flow valuation for every share on the TSX on a daily basis. If you want to find the calculation for other stocks, just search here.
This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
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