The shares of Uni-Select inc. (TSE:UNS) could be 41% below their estimated intrinsic value
The October share price for Uni-Select inc. (TSE:UNS) reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to their present value. This will be done using the discounted cash flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
See our latest analysis for Uni-Select
The calculation
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To begin with, we need to obtain cash flow estimates 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:
10-Year Free Cash Flow (FCF) Forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF ($, millions) | $98.4 million | $95.2 million | $94.0 million | $93.6 million | $93.8 million | $94.4 million | $95.3 million | $96.4 million | $97.6 million | $99.0 million |
Growth rate estimate Source | Analyst x4 | Analyst x1 | Is @ -1.29% | Is @ -0.41% | Is at 0.2% | Is at 0.63% | Is at 0.93% | Is at 1.14% | Is at 1.29% | Is at 1.39% |
Present value (in millions of dollars) discounted at 6.4% | $92.5 | $84.2 | $78.2 | $73.2 | $69.0 | $65.2 | $61.9 | $58.9 | $56.1 | $53.5 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $692 million
After calculating the present value of future cash flows over the initial 10-year 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 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)= FCF_{2032} × (1 + g) ÷ (r – g) = $99 million × (1 + 1.6%) ÷ (6.4%–1.6%) = $2.1 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $2.1 billion ÷ (1 + 6.4%)^{ten}= $1.2 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $1.8 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of C$34.2, the company appears to have pretty good value at a 41% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Important assumptions
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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Uni-Select as a potential shareholder, 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.
Look forward:
Although a business valuation is important, it is only one of many factors you need to assess for a business. DCF models are not the be-all and end-all 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 the company being undervalued or overvalued. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Can we understand why the company is trading at a discount to its intrinsic value? For Uni-Select, we have compiled three essential factors that you should explore further:
- Risks: For example, we discovered 1 warning sign for Uni-Select which you should be aware of before investing here.
- Management: Did insiders increase their shares to take advantage of market sentiment about UNS’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 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.
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