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Estimating The Intrinsic Value Of Fortuna Silver Mines Inc. (TSE:FVI)

Key Insights

  • The projected fair value for Fortuna Silver Mines is CA$5.15 based on 2 Stage Free Cash Flow to Equity

  • Current share price of CA$4.86 suggests Fortuna Silver Mines is potentially trading close to its fair value

  • Our fair value estimate is 10.0% lower than Fortuna Silver Mines' analyst price target of US$5.72

In this article we are going to estimate the intrinsic value of Fortuna Silver Mines Inc. (TSE:FVI) by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Fortuna Silver Mines

The Calculation

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, 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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$201.5m

US$151.4m

US$108.0m

US$85.6m

US$73.7m

US$66.9m

US$63.0m

US$60.8m

US$59.6m

US$59.2m

Growth Rate Estimate Source

Analyst x4

Analyst x3

Analyst x1

Est @ -20.74%

Est @ -13.94%

Est @ -9.18%

Est @ -5.84%

Est @ -3.51%

Est @ -1.88%

Est @ -0.74%

Present Value ($, Millions) Discounted @ 8.0%

US$187

US$130

US$85.8

US$63.0

US$50.2

US$42.3

US$36.9

US$32.9

US$29.9

US$27.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$685m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 8.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$59m× (1 + 1.9%) ÷ (8.0%– 1.9%) = US$1.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.0b÷ ( 1 + 8.0%)10= US$466m

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 US$1.2b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$4.9, the company appears about fair value at a 5.6% 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

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 Fortuna Silver Mines 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 8.0%, which is based on a levered beta of 1.205. 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 Fortuna Silver Mines

Strength

  • Debt is not viewed as a risk.

Weakness

  • 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.

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

Threat

  • Revenue is forecast to decrease over the next 2 years.

Next Steps:

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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Fortuna Silver Mines, there are three pertinent factors you should look at:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Fortuna Silver Mines , and understanding it should be part of your investment process.

  2. Future Earnings: How does FVI'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.

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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