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Gold Road Resources Limited (ASX:GOR) Shares Could Be 48% Below Their Intrinsic Value Estimate

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How far off is Gold Road Resources Limited (ASX:GOR) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

Check out our latest analysis for Gold Road Resources

What's The Estimated Valuation?

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. To begin with, we have to get estimates of 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 (A$, Millions)

AU$131.7m

AU$155.7m

AU$173.5m

AU$158.9m

AU$150.8m

AU$146.2m

AU$143.9m

AU$143.1m

AU$143.4m

AU$144.3m

Growth Rate Estimate Source

Analyst x5

Analyst x3

Analyst x1

Analyst x1

Est @ -5.11%

Est @ -3.03%

Est @ -1.57%

Est @ -0.55%

Est @ 0.16%

Est @ 0.66%

Present Value (A$, Millions) Discounted @ 6.5%

AU$124

AU$137

AU$144

AU$123

AU$110

AU$100

AU$92.4

AU$86.3

AU$81.1

AU$76.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.1b

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 (1.8%) 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 6.5%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = AU$144m× (1 + 1.8%) ÷ (6.5%– 1.8%) = AU$3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$3.1b÷ ( 1 + 6.5%)10= AU$1.7b

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 AU$2.7b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$1.3, the company appears quite good value at a 48% 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
dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Gold Road Resources 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 6.5%, which is based on a levered beta of 1.109. 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.

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. 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. What is the reason for the share price sitting below the intrinsic value? For Gold Road Resources, there are three essential factors you should look at:

  1. Risks: For example, we've discovered 2 warning signs for Gold Road Resources that you should be aware of before investing here.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for GOR'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. Simply Wall St updates its DCF calculation for every Australian 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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