Is Hudbay Minerals Inc. (TSE:HBM) Expensive For A Reason? A Look At Its Intrinsic Value
Key Insights
The projected fair value for Hudbay Minerals is CA$5.69 based on 2 Stage Free Cash Flow to Equity
Current share price of CA$7.14 suggests Hudbay Minerals is potentially 25% overvalued
The US$9.53 analyst price target for HBM is 67% more than our estimate of fair value
Does the January share price for Hudbay Minerals Inc. (TSE:HBM) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Check out our latest analysis for Hudbay Minerals
Step By Step Through The Calculation
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$464.7m | US$255.0m | US$160.7m | US$120.1m | US$99.5m | US$88.2m | US$81.6m | US$77.9m | US$75.8m | US$74.8m |
Growth Rate Estimate Source | Analyst x4 | Analyst x2 | Est @ -36.97% | Est @ -25.30% | Est @ -17.13% | Est @ -11.41% | Est @ -7.41% | Est @ -4.61% | Est @ -2.65% | Est @ -1.27% |
Present Value ($, Millions) Discounted @ 9.6% | US$424 | US$212 | US$122 | US$83.1 | US$62.8 | US$50.7 | US$42.8 | US$37.3 | US$33.1 | US$29.8 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$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 (1.9%) 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 9.6%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$75m× (1 + 1.9%) ÷ (9.6%– 1.9%) = US$989m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$989m÷ ( 1 + 9.6%)10= US$394m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$1.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CA$7.1, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The 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 Hudbay Minerals 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 9.6%, which is based on a levered beta of 1.543. 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 Hudbay Minerals
Strength
Debt is well covered by cash flow.
Weakness
Earnings declined over the past year.
Interest payments on debt are not well covered.
Dividend is low compared to the top 25% of dividend payers in the Metals and Mining market.
Expensive based on P/E ratio and estimated fair value.
Shareholders have been diluted in the past year.
Opportunity
Annual earnings are forecast to grow faster than the Canadian market.
Threat
Revenue is forecast to grow slower than 20% per year.
Next Steps:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value lower than the current share price? For Hudbay Minerals, we've put together three fundamental aspects you should further research:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Hudbay Minerals (at least 1 which can't be ignored) , and understanding these should be part of your investment process.
Future Earnings: How does HBM'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 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSX 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.
