Estimated intrinsic value of Toromont Industries Ltd. (TSE: TIH)
Today we are going to walk through one way to estimate the intrinsic value of Toromont Industries Ltd. (TSE: TIH) by projecting its future cash flows and then discounting them to present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to do, although it may seem quite complex.
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 still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
See our latest analysis for Toromont Industries
We use what is called a 2-stage 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, and so the sum of these future cash flows is then discounted to today’s value:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (CA$, Millions)||C$206.5 million||C$344.7 million||C$383.1 million||C$410.9 million||C$433.6 million||C$452.4 million||C$468.3 million||C$481.9 million||CA$494.0m||C$505.0 million|
|Growth rate estimate Source||Analyst x3||Analyst x3||Analyst x1||Is at 7.25%||Is at 5.54%||Is at 4.34%||Is at 3.5%||Is at 2.92%||Is at 2.51%||Is at 2.22%|
|Present value (CA$, millions) discounted at 6.4%||CA$194||CA$304||CA$318||CA$320||CA$318||CA$311||CA$303||CA$293||CA$282||CA$271|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = 2.9 billion Canadian dollars
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. 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 5-year average of the 10-year government bond yield (1.6%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.4%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = C$505 million × (1 + 1.6%) ÷ (6.4%–1.6%) = C$11 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= C$11B÷ ( 1 + 6.4%)ten= 5.6 billion Canadian dollars
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is C$8.6 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of C$107, the company appears around fair value 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.
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. 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 consider Toromont Industries 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 takes debt into account. In this calculation, we used 6.4%, which is based on a leveraged beta of 1.114. 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.
Valuation is only one side of the coin in terms of crafting your investment thesis, and it 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 must be true for this stock to be under/overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For Toromont Industries, we have put together three fundamental aspects that you should consider:
- Risks: Take for example the ubiquitous specter of investment risk. We have identified 1 warning sign with Toromont Industries, and understanding this should be part of your investment process.
- Future earnings: How does TIH’s growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- 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 for every Canadian stock daily, 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 long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.