In this article I am going to calculate the intrinsic value of Fortescue Metals Group Limited (ASX:FMG) using the discounted cash flows (DCF) model. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. If you are reading this after January 2018 then I highly recommend you check out the latest calculation for Fortescue Metals Group here.
Is FMG fairly valued?
I’ve used the 2-stage growth model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. To begin, I pulled together the analyst consensus forecast of FMG’s levered free cash flow (FCF) over the next five years and discounted these figures at the rate of 11.24%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of $5,361.0M. Want to know how I arrived at this number? Check out our detailed analysis here.
Above is a visual representation of how FMG’s earnings are expected to move going forward, which should give you some color on FMG’s outlook. Now we need to calculate the terminal value, which accounts for all the future cash flows after the five years. It’s appropriate to use the 10-year government bond rate of 2.8% as the stable growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is $11,172.1M.
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 $16,533.1M. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value of A$6.78, which, compared to the current share price of A$5.23, we find that Fortescue Metals Group is about right, perhaps slightly undervalued at a 22.87% discount to what it is available for right now.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and 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 FMG, I’ve compiled three key aspects you should look at:
PS. Simply Wall St does a DCF calculation for every AU stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.