In this article we are going to estimate the intrinsic value of Keyera Corp. (TSE:KEY) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (CA$, Millions)
CA$729.3m
CA$719.0m
CA$785.3m
CA$765.0m
CA$757.1m
CA$756.7m
CA$761.3m
CA$769.5m
CA$780.3m
CA$793.1m
Growth Rate Estimate Source
Analyst x6
Analyst x5
Analyst x3
Analyst x2
Est @ -1.03%
Est @ -0.06%
Est @ 0.61%
Est @ 1.08%
Est @ 1.41%
Est @ 1.64%
Present Value (CA$, Millions) Discounted @ 7.6%
CA$678
CA$621
CA$631
CA$571
CA$526
CA$488
CA$457
CA$429
CA$405
CA$382
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CA$5.2b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$15b÷ ( 1 + 7.6%)10= CA$7.2b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CA$12b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$38.3, the company appears a touch undervalued at a 29% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
dcf
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Keyera 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 accounts for debt. In this calculation we've used 7.6%, which is based on a levered beta of 1.309. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for Keyera
Strength
Earnings growth over the past year exceeded the industry.
Debt is well covered by earnings and cashflows.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Trading below our estimate of fair value by more than 20%.
Threat
Dividends are not covered by earnings.
Annual earnings are forecast to grow slower than the Canadian market.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Keyera, we've compiled three fundamental items you should assess:
Future Earnings: How does KEY's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSX every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
