Do Empire Company Limited (TSE:EMP.A) investors pay above intrinsic value?
How far is Empire Company Limited (TSE:EMP.A) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by estimating the company’s future cash flows and discounting them to their present value. This will be done using the discounted cash flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.
See our latest review for Empire
The model
We use what is called a 2step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
2022 
2023 
2024 
2025 
2026 
2027 
2028 
2029 
2030 
2031 

Leveraged FCF (CA$, Millions) 
C$624.7 million 
C$660.0 million 
C$666.9 million 
C$485.2 million 
CA$395.0m 
C$345.4 million 
C$316.7 million 
C$299.7 million 
C$289.9 million 
C$284.6 million 
Growth rate estimate Source 
Analyst x4 
Analyst x4 
Analyst x1 
Is @ 27.24% 
East @ 18.6% 
East @ 12.55% 
Is @ 8.32% 
Is @ 5.35% 
Is @ 3.28% 
Is @ 1.83% 
Present value (CA$, millions) discounted at 5.3% 
CA$593 
$595 CAD 
CA$571 
$394 CAD 
CA$305 
CA$253 
CA$220 
CA$198 
CA$182 
$169 CAD 
(“East” = FCF growth rate estimated by Simply Wall St)
10year discounted cash flow (PVCF) = 3.5 billion Canadian dollars
After calculating the present value of future cash flows over the initial 10year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5year average of the 10year government bond yield (1.6%) to estimate future growth. Similar to the 10year “growth” period, we discount future cash flows to present value, using a cost of equity of 5.3%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = C$285 million × (1 + 1.6%) ÷ (5.3%–1.6%) = C$7.7 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= C$7.7B÷ ( 1 + 5.3%)^{ten}= 4.6 billion Canadian dollars
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is C$8.0 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of C$40.9, the company looks reasonably expensive at the time of writing. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
The hypotheses
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Empire 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 factors in debt. In this calculation, we used 5.3%, which is based on a leveraged beta of 0.889. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
Although a business valuation is important, it is only one of many factors you need to assess for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of 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 riskfree rate changes sharply, output may be very different. Why is intrinsic value lower than the current stock price? For Empire, there are three key aspects you should explore:

Financial health: Does EMP.A have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.

Management: Did insiders increase their shares to take advantage of market sentiment regarding EMP.A’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.

Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation daily for every Canadian stock, so if you want to find the intrinsic value of any other stock, do a search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted longterm analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from pricesensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.