Today we will run through one way of estimating the intrinsic value of Queen's Road Capital Investment Ltd. (TSE:QRC) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$8.80m
US$10.7m
US$12.4m
US$13.8m
US$15.0m
US$16.1m
US$17.0m
US$17.8m
US$18.5m
US$19.1m
Growth Rate Estimate Source
Est @ 29.59%
Est @ 21.42%
Est @ 15.70%
Est @ 11.70%
Est @ 8.90%
Est @ 6.94%
Est @ 5.56%
Est @ 4.60%
Est @ 3.93%
Est @ 3.46%
Present Value ($, Millions) Discounted @ 8.2%
US$8.1
US$9.1
US$9.8
US$10.1
US$10.1
US$10.0
US$9.8
US$9.5
US$9.1
US$8.7
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$94m
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 a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.4%) 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 8.2%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$336m÷ ( 1 + 8.2%)10= US$153m
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$247m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CA$7.1, the company appears about fair value at a 1.3% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
TSX:QRC Discounted Cash Flow February 17th 2025
Important Assumptions
We would point out that 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 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 Queen's Road Capital Investment 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 8.2%, which is based on a levered beta of 1.134. 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 Queen's Road Capital Investment
Strength
Earnings growth over the past year exceeded its 5-year average.
Debt is not viewed as a risk.
Weakness
Earnings growth over the past year underperformed the Metals and Mining industry.
Dividend is low compared to the top 25% of dividend payers in the Metals and Mining market.
Opportunity
Current share price is below our estimate of fair value.
Lack of analyst coverage makes it difficult to determine QRC's earnings prospects.
Threat
Dividends are not covered by cash flow.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Queen's Road Capital Investment, we've put together three essential elements you should further examine:
Risks: Take risks, for example - Queen's Road Capital Investment has 1 warning sign we think you should be aware of.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for QRC's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.
