In this article we are going to estimate the intrinsic value of Polaris Renewable Energy Inc. (TSE:PIF) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF ($, Millions)
US$32.7m
US$22.2m
US$16.9m
US$14.1m
US$12.6m
US$11.8m
US$11.3m
US$11.0m
US$10.9m
US$10.9m
Growth Rate Estimate Source
Analyst x1
Analyst x1
Est @ -24.02%
Est @ -16.19%
Est @ -10.71%
Est @ -6.87%
Est @ -4.19%
Est @ -2.31%
Est @ -0.99%
Est @ -0.07%
Present Value ($, Millions) Discounted @ 6.0%
US$30.8
US$19.7
US$14.1
US$11.2
US$9.4
US$8.3
US$7.5
US$6.9
US$6.4
US$6.1
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$120m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.0%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$281m÷ ( 1 + 6.0%)10= US$157m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$277m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CA$12.3, the company appears quite good value at a 32% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
TSX:PIF Discounted Cash Flow May 6th 2024
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Polaris Renewable Energy 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 accounts for debt. In this calculation we've used 6.0%, which is based on a levered beta of 0.859. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for Polaris Renewable Energy
Strength
Earnings growth over the past year exceeded the industry.
Debt is well covered by cash flow.
Dividend is in the top 25% of dividend payers in the market.
Weakness
Interest payments on debt are not well covered.
Opportunity
Annual earnings are forecast to grow faster than the Canadian market.
Good value based on P/E ratio and estimated fair value.
Significant insider buying over the past 3 months.
Threat
Dividends are not covered by earnings.
Annual revenue is forecast to grow slower than the Canadian market.
Moving On:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For Polaris Renewable Energy, we've put together three further elements you should consider:
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PIF's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
