Does the May share price for Greenlane Renewables Inc. (TSE:GRN) reflect what it’s really worth? Today we are going to estimate the intrinsic value of the stock by projecting its future cash flows and then discounting them to the present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
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. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.
Check out our latest analysis for Greenlane Renewables
We will use a two-stage 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 “sustained growth”. 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.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (CA$, Millions)||-CA$1.40m||3.27 million Canadian dollars||CA$4.66m||CA$6.06m||CA$7.38m||CA$8.53m||CA$9.50m||C$10.3 million||C$11.0 million||11.5 million Canadian dollars|
|Growth rate estimate Source||Analyst x2||Analyst x2||Is at 42.53%||East @ 30.24%||Is at 21.64%||Is at 15.61%||Is at 11.4%||Is at 8.45%||Is at 6.38%||Is at 4.93%|
|Present value (CA$, millions) discounted at 6.7%||-CA$1.3||CA$2.9||CA$3.8||CA$4.7||CA$5.3||CA$5.8||CA$6.0||CA$6.1||CA$6.1||CA$6.0|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = 45 million Canadian dollars
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. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.6%. We discount the terminal cash flows to their present value at a cost of equity of 6.7%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = C$12 million × (1 + 1.6%) ÷ (6.7%–1.6%) = C$229 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= CA$229m ( 1 + 6.7%)ten= 120 million 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$165 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of C$0.7, the company appears to have pretty good value at a 32% discount to the current share price. 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.
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. 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 complete picture of a company’s potential performance. Since we consider Greenlane Renewables 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 6.7%, which is based on a leveraged beta of 1.204. 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.
Let’s move on :
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. The DCF model is not a perfect stock valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/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 Greenlane Renewables, we have compiled three additional aspects that you should consider in more detail:
- Risks: For example, we found 3 warning signs for Greenlane Renewables that you must consider before investing here.
- Future earnings: How does GRN’s growth rate compare to its peers and the market in general? 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.