The Pan American Silver Corp. (TSE: PAAS) worth CA $ 40.1 based on its intrinsic value?
The June share price for Pan American Silver Corp. (TSE: PAAS) reflect its real value? Today, we’re going to estimate the intrinsic value of the stock by projecting its future cash flows, then discounting them to today’s value. Our analysis will use the discounted cash flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
There are many ways businesses can be assessed, so we would like to stress that a DCF is not perfect for all situations. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be of interest to you.
See our latest review for Pan American Silver
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. 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.
In general, 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 the present value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||US $ 221.0 million||US $ 688.0 million||US $ 614.3 million||US $ 551.0 million||US $ 358.0 million||US $ 311.9 million||US $ 285.2 million||US $ 269.5 million||US $ 260.3 million||US $ 255.3 million|
|Source of estimated growth rate||Analyst x7||Analyst x7||Analyst x5||Analyst x1||Analyst x1||Is @ -12.87%||Is @ -8.55%||Is @ -5.53%||Is @ -3.41%||Est @ -1.93%|
|Present value (in millions of dollars) discounted at 6.5%||$ 207||US $ 606||$ 508||$ 428||US $ 261||213 USD||183 USD||163 USD||$ 147||136 USD|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 2.9 billion
It is now a matter of calculating the Terminal Value, which takes into account all 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 used the 5-year average of the 10-year government bond yield (1.5%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 6.5%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US $ 255 million × (1 + 1.5%) ÷ (6.5% to 1.5%) = US $ 5.2 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 5.2 billion ÷ (1 + 6.5%)ten= 2.8 billion US dollars
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is US $ 5.6 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of C $ 40.1, the company appears slightly overvalued at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own 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 Pan American Silver 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 6.5%, which is based on a leveraged beta of 1.058. 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.
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. It is not possible to achieve a rock-solid 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 undervaluation or overvaluation of the company. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Can we understand why the company is trading at a premium over intrinsic value? For Pan American Silver, there are three key factors you should research further:
- Financial health: Does PAAS have a healthy track record? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future benefits: How does PAAS’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of another 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 the mentioned stocks.
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