Savaria Corporation (TSE:SIS) Shares Could Be 26% Below Their Intrinsic Value Estimate

editorial-team@simplywallst.com (Simply Wall St)

Sun, Jan 7, 2024, 5:24 AM 6 min read

Does the January share price for Savaria Corporation (TSE:SIS) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Savaria

The Method

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 start off with, we need to estimate 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, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$80.0m	CA$82.4m	CA$84.4m	CA$86.4m	CA$88.3m	CA$90.1m	CA$92.0m	CA$93.8m	CA$95.7m	CA$97.6m
Growth Rate Estimate Source	Analyst x3	Analyst x1	Est @ 2.46%	Est @ 2.30%	Est @ 2.19%	Est @ 2.11%	Est @ 2.06%	Est @ 2.02%	Est @ 1.99%	Est @ 1.97%
Present Value (CA$, Millions) Discounted @ 7.8%	CA$74.2	CA$70.9	CA$67.4	CA$63.9	CA$60.6	CA$57.4	CA$54.3	CA$51.4	CA$48.6	CA$46.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$595m

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 (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 7.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$98m× (1 + 1.9%) ÷ (7.8%– 1.9%) = CA$1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$1.7b÷ ( 1 + 7.8%)¹⁰= CA$797m

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$1.4b. 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$14.9, the company appears a touch undervalued at a 26% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf — TSX:SIS Discounted Cash Flow January 7th 2024

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Savaria 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 7.8%, which is based on a levered beta of 1.176. 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 Savaria

Strength

Earnings growth over the past year exceeded the industry.

Debt is well covered by earnings and cashflows.

Dividends are covered by earnings and cash flows.

Weakness

Dividend is low compared to the top 25% of dividend payers in the Machinery market.

Shareholders have been diluted in the past year.

Opportunity

Annual earnings are forecast to grow faster than the Canadian market.

Trading below our estimate of fair value by more than 20%.

Significant insider buying over the past 3 months.

Threat

Annual revenue is forecast to grow slower than the Canadian market.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. What is the reason for the share price sitting below the intrinsic value? For Savaria, we've put together three fundamental aspects you should explore:

Risks: For example, we've discovered 2 warning signs for Savaria that you should be aware of before investing here.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SIS'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.