Is There An Opportunity With SATO Technologies Corp.'s (CVE:SATO) 32% Undervaluation?
editorial-team@simplywallst.com (Simply Wall St)
6 min read
Key Insights
Using the 2 Stage Free Cash Flow to Equity, SATO Technologies fair value estimate is CA$0.78
Current share price of CA$0.53 suggests SATO Technologies is potentially 32% undervalued
When compared to theindustry average discount to fair value of 17%, SATO Technologies' competitors seem to be trading at a lesser discount
How far off is SATO Technologies Corp. (CVE:SATO) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
View our latest analysis for SATO Technologies
What's The Estimated Valuation?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. 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 (CA$, Millions)
CA$3.44m
CA$3.42m
CA$3.43m
CA$3.45m
CA$3.49m
CA$3.53m
CA$3.59m
CA$3.65m
CA$3.71m
CA$3.78m
Growth Rate Estimate Source
Analyst x1
Analyst x1
Est @ 0.20%
Est @ 0.72%
Est @ 1.08%
Est @ 1.34%
Est @ 1.52%
Est @ 1.64%
Est @ 1.73%
Est @ 1.79%
Present Value (CA$, Millions) Discounted @ 7.6%
CA$3.2
CA$3.0
CA$2.7
CA$2.6
CA$2.4
CA$2.3
CA$2.1
CA$2.0
CA$1.9
CA$1.8
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CA$24m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.9%) 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 7.6%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$67m÷ ( 1 + 7.6%)10= CA$32m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CA$56m. 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$0.5, the company appears quite undervalued at a 32% 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.
TSXV:SATO Discounted Cash Flow January 10th 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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 SATO Technologies 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 7.6%, which is based on a levered beta of 1.140. 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 SATO Technologies
Strength
Debt is well covered by earnings and cashflows.
Weakness
Shareholders have been diluted in the past year.
Opportunity
Expected to breakeven next year.
Trading below our estimate of fair value by more than 20%.
Threat
Has less than 3 years of cash runway based on current free cash flow.
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For SATO Technologies, we've compiled three important aspects you should consider:
Risks: You should be aware of the 4 warning signs for SATO Technologies we've uncovered before considering an investment in the company.
Future Earnings: How does SATO's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years 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 is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSXV every day. If you want to find the calculation for other stocks just search here.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
