Estimating The Intrinsic Value Of AutoCanada Inc. (TSE:ACQ)

Key Insights

• The projected fair value for AutoCanada is CA$26.97 based on 2 Stage Free Cash Flow to Equity

• Current share price of CA$26.29 suggests AutoCanada is potentially trading close to its fair value

• Analyst price target for ACQ is CA$32.50, which is 21% above our fair value estimate

Does the November share price for AutoCanada Inc. (TSE:ACQ) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

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. 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 AutoCanada

Is AutoCanada Fairly Valued?

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$91.1m	CA$79.6m	CA$73.0m	CA$69.2m	CA$67.1m	CA$66.0m	CA$65.7m	CA$65.8m	CA$66.3m	CA$67.0m
Growth Rate Estimate Source	Analyst x5	Est @ -12.66%	Est @ -8.28%	Est @ -5.22%	Est @ -3.07%	Est @ -1.57%	Est @ -0.52%	Est @ 0.21%	Est @ 0.73%	Est @ 1.09%
Present Value (CA$, Millions) Discounted @ 12%	CA$81.4	CA$63.5	CA$52.1	CA$44.1	CA$38.2	CA$33.6	CA$29.8	CA$26.7	CA$24.0	CA$21.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$415m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 12%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$67m× (1 + 1.9%) ÷ (12%– 1.9%) = CA$683m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$683m÷ ( 1 + 12%)¹⁰= CA$221m

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$636m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$26.3, the company appears about fair value at a 2.5% discount to where the stock price trades currently. 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

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 AutoCanada 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 12%, 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 AutoCanada

Strength

• No major strengths identified for ACQ.

Weakness

• Earnings declined over the past year.

• Interest payments on debt are not well covered.

Opportunity

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

Threat

• Debt is not well covered by operating cash flow.

• Annual revenue is forecast to grow slower than the Canadian market.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For AutoCanada, we've put together three relevant factors you should explore:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with AutoCanada (at least 1 which can't be ignored) , and understanding these should be part of your investment process.

2. Future Earnings: How does ACQ'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. 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.