Calculating The Intrinsic Value Of Acadian Timber Corp. (TSE:ADN)

Key Insights

• Acadian Timber's estimated fair value is CA$14.37 based on 2 Stage Free Cash Flow to Equity

• Acadian Timber's CA$16.38 share price indicates it is trading at similar levels as its fair value estimate

• Acadian Timber's peers seem to be trading at a higher premium to fair value based onthe industry average of -14%

Today we will run through one way of estimating the intrinsic value of Acadian Timber Corp. (TSE:ADN) 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Acadian Timber

Is Acadian Timber Fairly Valued?

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 start off with, we need to estimate 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$15.6m	CA$17.0m	CA$18.0m	CA$18.8m	CA$19.5m	CA$20.2m	CA$20.8m	CA$21.3m	CA$21.8m	CA$22.3m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 5.92%	Est @ 4.73%	Est @ 3.89%	Est @ 3.30%	Est @ 2.89%	Est @ 2.60%	Est @ 2.40%	Est @ 2.26%
Present Value (CA$, Millions) Discounted @ 9.3%	CA$14.3	CA$14.2	CA$13.7	CA$13.2	CA$12.5	CA$11.8	CA$11.1	CA$10.5	CA$9.8	CA$9.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$120m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 9.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$22m× (1 + 1.9%) ÷ (9.3%– 1.9%) = CA$308m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$308m÷ ( 1 + 9.3%)¹⁰= CA$127m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CA$247m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$16.4, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf

Important Assumptions

Now 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 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 Acadian Timber 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 9.3%, which is based on a levered beta of 1.475. 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 Acadian Timber

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is well covered by earnings.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• ADN's financial characteristics indicate limited near-term opportunities for shareholders.

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by cash flow.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Acadian Timber, we've compiled three further items you should explore:

1. Risks: We feel that you should assess the 3 warning signs for Acadian Timber (1 is significant!) we've flagged before making an investment in the company.

2. Future Earnings: How does ADN'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.

3. 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.