Estimating The Intrinsic Value Of Spectra Products Inc. (CVE:SSA)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Spectra Products fair value estimate is CA$0.25
Spectra Products' CA$0.24 share price indicates it is trading at similar levels as its fair value estimate
Industry average discount to fair value of 47% suggests Spectra Products' peers are currently trading at a higher discount
In this article we are going to estimate the intrinsic value of Spectra Products Inc. (CVE:SSA) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Spectra Products
The Method
We're 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 a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (CA$, Millions) | CA$324.3k | CA$290.2k | CA$270.5k | CA$259.1k | CA$252.9k | CA$250.1k | CA$249.6k | CA$250.6k | CA$252.7k | CA$255.6k |
Growth Rate Estimate Source | Est @ -15.81% | Est @ -10.51% | Est @ -6.80% | Est @ -4.20% | Est @ -2.38% | Est @ -1.11% | Est @ -0.22% | Est @ 0.40% | Est @ 0.84% | Est @ 1.15% |
Present Value (CA$, Millions) Discounted @ 8.2% | CA$0.3 | CA$0.2 | CA$0.2 | CA$0.2 | CA$0.2 | CA$0.2 | CA$0.1 | CA$0.1 | CA$0.1 | CA$0.1 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$1.8m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$256k× (1 + 1.9%) ÷ (8.2%– 1.9%) = CA$4.1m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$4.1m÷ ( 1 + 8.2%)10= CA$1.9m
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$3.7m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$0.2, the company appears about fair value at a 3.7% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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 Spectra Products 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 8.2%, which is based on a levered beta of 1.271. 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 Spectra Products
Strength
Earnings growth over the past year exceeded its 5-year average.
Currently debt free.
Weakness
Earnings growth over the past year underperformed the Auto Components industry.
Opportunity
Current share price is below our estimate of fair value.
Lack of analyst coverage makes it difficult to determine SSA's earnings prospects.
Threat
No apparent threats visible for SSA.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Spectra Products, we've put together three further aspects you should assess:
Risks: As an example, we've found 3 warning signs for Spectra Products (2 don't sit too well with us!) that you need to consider before investing here.
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!
Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSXV every day. If you want to find the calculation for other stocks 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.
