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Is Enerflex Ltd. (TSE:EFX) Trading At A 42% Discount?

Key Insights

  • The projected fair value for Enerflex is CA$14.30 based on 2 Stage Free Cash Flow to Equity

  • Current share price of CA$8.28 suggests Enerflex is potentially 42% undervalued

  • Our fair value estimate is similar to Enerflex's analyst price target of CA$14.30

In this article we are going to estimate the intrinsic value of Enerflex Ltd. (TSE:EFX) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Enerflex

Is Enerflex Fairly Valued?

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.

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

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF (CA$, Millions)

CA$186.3m

CA$295.3m

CA$261.0m

CA$241.7m

CA$230.4m

CA$224.2m

CA$221.1m

CA$220.2m

CA$220.8m

CA$222.3m

Growth Rate Estimate Source

Analyst x6

Analyst x6

Analyst x1

Est @ -7.41%

Est @ -4.65%

Est @ -2.71%

Est @ -1.36%

Est @ -0.41%

Est @ 0.25%

Est @ 0.72%

Present Value (CA$, Millions) Discounted @ 14%

CA$164

CA$229

CA$178

CA$145

CA$121

CA$104

CA$90.1

CA$78.9

CA$69.6

CA$61.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$1.2b

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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CA$222m× (1 + 1.8%) ÷ (14%– 1.8%) = CA$1.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$1.9b÷ ( 1 + 14%)10= CA$529m

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$1.8b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$8.3, the company appears quite good value at a 42% discount to where the stock price trades currently. 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
dcf

The 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 Enerflex 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 14%, which is based on a levered beta of 2.000. 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 Enerflex

Strength

  • No major strengths identified for EFX.

Weakness

  • Interest payments on debt are not well covered.

  • Dividend is low compared to the top 25% of dividend payers in the Energy Services market.

  • Shareholders have been diluted in the past year.

Opportunity

  • Expected to breakeven next year.

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

  • Good value based on P/S ratio and estimated fair value.

Threat

  • Debt is not well covered by operating cash flow.

  • Paying a dividend but company is unprofitable.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. Why is the intrinsic value higher than the current share price? For Enerflex, we've put together three pertinent factors you should further examine:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Enerflex (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for EFX'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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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