Calculating The Intrinsic Value Of Deterra Royalties Limited (ASX:DRR)
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Deterra Royalties Limited (ASX:DRR) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for Deterra Royalties
The model
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Levered FCF (A$, Millions) | AU$168.7m | AU$178.3m | AU$145.5m | AU$135.0m | AU$101.0m | AU$89.3m | AU$82.6m | AU$78.7m | AU$76.5m | AU$75.5m |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Analyst x2 | Analyst x1 | Analyst x1 | Est @ -11.57% | Est @ -7.54% | Est @ -4.72% | Est @ -2.75% | Est @ -1.36% |
Present Value (A$, Millions) Discounted @ 6.5% | AU$158 | AU$157 | AU$120 | AU$105 | AU$73.6 | AU$61.1 | AU$53.0 | AU$47.4 | AU$43.3 | AU$40.1 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$859m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 6.5%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = AU$75m× (1 + 1.9%) ÷ (6.5%– 1.9%) = AU$1.6b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$1.6b÷ ( 1 + 6.5%)10= AU$875m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$1.7b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$3.8, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Deterra Royalties 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 6.5%, which is based on a levered beta of 1.066. 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.
Moving On:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Deterra Royalties, we've compiled three essential aspects you should consider:
Risks: Be aware that Deterra Royalties is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for DRR's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock just search here.
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.
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