How far is Panoramic Resources Limited (ASX:PAN) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the company’s expected future cash flows and discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Check out our latest analysis for scenic resources
We use what is called a 2-step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. 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.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (A$, Millions)||-A$19.0 million||A$104.0 million||A$81.0 million||A$68.5 million||A$61.5 million||A$57.4 million||A$55.0 million||A$53.7 million||A$53.1 million||A$53.0 million|
|Growth rate estimate Source||Analyst x1||Analyst x1||Analyst x1||East @ -15.44%||Is @ -10.27%||Is @ -6.65%||East @ -4.11%||Is @ -2.34%||Is @ -1.1%||Is @ -0.23%|
|Present value (A$, millions) discounted at 6.6%||-AU$17.8||AU$91.5||AU$66.9||AU$53.0||AU$44.6||AU$39.1||AU$35.2||AU$32.2||AU$29.9||AU$28.0|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = 402 million Australian dollars
The second stage is also known as the terminal value, it is the cash flow of the business after 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 1.8%. We discount the terminal cash flows to their present value at a cost of equity of 6.6%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = AU$53 million × (1 + 1.8%) ÷ (6.6%–1.8%) = AU$1.1 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= AU$1.1 billion÷ (1 + 6.6%)ten= AU$593 million
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is A$995 million. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of AU$0.4, the company looks slightly undervalued at a 24% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. 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 Panoramic Resources 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 takes debt into account. In this calculation, we used 6.6%, which is based on a leveraged beta of 1.133. 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.
Although a business valuation is important, it is only one of many factors you need to assess for a business. DCF models are not the be-all and end-all of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. Why is intrinsic value higher than the current stock price? For Panoramic Resources, we’ve put together three essential aspects you should consider:
- Risks: To this end, you should inquire about the 2 warning signs we spotted with Panoramic Resources (including 1 which is a little worrying).
- Future earnings: How does PAN’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks, 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.