Does This Valuation Of Aurion Resources Ltd. (CVE:AU) Imply Investors Are Overpaying?

Key Insights

• Aurion Resources' estimated fair value is CA$0.49 based on 2 Stage Free Cash Flow to Equity

• Aurion Resources is estimated to be 23% overvalued based on current share price of CA$0.60

• Industry average of 39% suggests Aurion Resources' peers are currently trading at a higher premium to fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Aurion Resources Ltd. (CVE:AU) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

View our latest analysis for Aurion Resources

The Model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	-CA$9.13m	-CA$40.0m	-CA$200.0m	CA$13.0m	CA$15.1m	CA$16.9m	CA$18.5m	CA$19.7m	CA$20.8m	CA$21.7m
Growth Rate Estimate Source	Est @ 22.57%	Analyst x1	Analyst x1	Analyst x2	Est @ 16.36%	Est @ 12.01%	Est @ 8.96%	Est @ 6.83%	Est @ 5.34%	Est @ 4.30%
Present Value (CA$, Millions) Discounted @ 7.4%	-CA$8.5	-CA$34.7	-CA$161	CA$9.8	CA$10.6	CA$11.0	CA$11.2	CA$11.1	CA$10.9	CA$10.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = -CA$129m

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$22m× (1 + 1.9%) ÷ (7.4%– 1.9%) = CA$395m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$395m÷ ( 1 + 7.4%)¹⁰= CA$193m

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$64m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CA$0.6, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

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. 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 Aurion Resources 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 7.4%, which is based on a levered beta of 1.116. 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 Aurion Resources

Strength

• Currently debt free.

Weakness

• Current share price is above our estimate of fair value.

• Shareholders have been diluted in the past year.

Opportunity

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

Threat

• Has less than 3 years of cash runway based on current free cash flow.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price exceeding the intrinsic value? For Aurion Resources, we've put together three further items you should consider:

1. Risks: Take risks, for example - Aurion Resources has 5 warning signs (and 2 which make us uncomfortable) we think you should know about.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AU's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. 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 Canadian stock every day, so if you want to find the intrinsic value of any other stock 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.