Does the share price for Stantec Inc (TSE:STN) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by taking the expected future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not August 2018 then I highly recommend you check out the latest calculation for Stantec by following the link below.
Is STN fairly valued?
I’m 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 perpetual stable growth rate. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF (CA$, Millions)||CA$116.02||CA$254.53||CA$294.00||CA$342.60||CA$397.42|
|Source||Analyst x7||Analyst x7||Analyst x1||Est @ 16.53%||Est @ 16%, capped from 16.53%|
|Present Value Discounted @ 12.26%||CA$103.35||CA$201.95||CA$207.79||CA$215.69||CA$222.86|
Present Value of 5-year Cash Flow (PVCF)= CA$951.64m
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.3%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 12.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CA$397.42m × (1 + 2.3%) ÷ (12.3% – 2.3%) = CA$4.10b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CA$4.10b ÷ ( 1 + 12.3%)5 = CA$2.30b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CA$3.25b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of CA$28.53. Relative to the current share price of CA$33.54, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
Now 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Stantec as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 12.3%, which is based on a levered beta of 1.296. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For STN, I’ve put together three key aspects you should further examine:
- Financial Health: Does STN have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does STN’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of STN? 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 does a DCF calculation for every CA stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.