Is Resolute Forest Products Inc. (NYSE: RFP) expensive for a reason? A look at its intrinsic value
Does Resolute Forest Products Inc. (NYSE: RFP) share price for June reflect true value? Today, we’re going to estimate the intrinsic value of the stock 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. There really isn’t much to do, although it might seem quite complex.
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. If you would like to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
Check out our latest review for Resolute Forest Products
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year free cash flow (FCF) forecast
|Leverage FCF ($, Millions)||US $ 369.7 million||166.3 million US dollars||US $ 85.9 million||US $ 57.4 million||US $ 44.4 million||US $ 37.6 million||US $ 33.8 million||US $ 31.6 million||US $ 30.4 million||US $ 29.7 million|
|Source of estimated growth rate||Analyst x4||Analyst x4||Is @ -48.33%||Is @ -33.23%||Is @ -22.67%||Is @ -15.27%||Is @ -10.09%||Is @ -6.47%||Is @ -3.93%||Est @ -2.15%|
|Present value (in millions of dollars) discounted at 11%||US $ 333||135 USD||US $ 62.8||US $ 37.8||$ 26.3||US $ 20.1||$ 16.3||$ 13.7||US $ 11.9||$ 10.4|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 667 million
The second stage is also known as terminal value, it is the cash flow of the business after the first stage. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount terminal cash flows to their present value at a cost of equity of 11%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US $ 30 million × (1 + 2.0%) ÷ (11% to 2.0%) = US $ 336 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 336 million ÷ (1 + 11%)ten= 118 million US dollars
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $ 785 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $ 13.0, the company looks potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these results, try the calculation yourself and play 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 full picture of a company’s potential performance. Since we consider Resolute Forest Products 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 into account debt. . In this calculation, we used 11%, which is based on a leveraged beta of 1.913. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of the many factors you need to evaluate for a business. DCF models are not the alpha and omega of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. Why is intrinsic value lower than the current share price? For Resolute Forest Products, you need to assess three other things:
- Risks: As an example, we have found 4 warning signs for Resolute Forest Products (1 makes us a little uncomfortable!) Which you should consider before investing here.
- Management: Have insiders increased their stocks to take advantage of market sentiment about RFP’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other strong companies: 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 trading fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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