Is Latin Resources Limited (ASX:LRS) Trading At A 29% Discount?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Latin Resources fair value estimate is AU$0.35

• Latin Resources is estimated to be 29% undervalued based on current share price of AU$0.24

• Our fair value estimate is 55% lower than Latin Resources' analyst price target of AU$0.77

In this article we are going to estimate the intrinsic value of Latin Resources Limited (ASX:LRS) 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. 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Latin Resources

What's The Estimated Valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

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 (A$, Millions)	-AU$20.0m	-AU$271.5m	AU$46.0m	AU$55.7m	AU$64.3m	AU$71.6m	AU$77.8m	AU$82.9m	AU$87.3m	AU$91.0m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Est @ 21.15%	Est @ 15.41%	Est @ 11.39%	Est @ 8.58%	Est @ 6.61%	Est @ 5.23%	Est @ 4.26%
Present Value (A$, Millions) Discounted @ 7.3%	-AU$18.6	-AU$236	AU$37.2	AU$42.0	AU$45.1	AU$46.8	AU$47.4	AU$47.1	AU$46.1	AU$44.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$102m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$91m× (1 + 2.0%) ÷ (7.3%– 2.0%) = AU$1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$1.7b÷ ( 1 + 7.3%)¹⁰= AU$858m

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$961m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$0.2, the company appears a touch undervalued at a 29% 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.

dcf

The 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. 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 Latin 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 7.3%, which is based on a levered beta of 1.065. 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 Latin Resources

Strength

• Currently debt free.

Weakness

• Shareholders have been diluted in the past year.

Opportunity

• Trading below our estimate of fair value by more than 20%.

Threat

• Has less than 3 years of cash runway based on current free cash flow.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. What is the reason for the share price sitting below the intrinsic value? For Latin Resources, we've compiled three relevant items you should consider:

1. Risks: For example, we've discovered 4 warning signs for Latin Resources (1 shouldn't be ignored!) that you should be aware of before investing here.

2. Future Earnings: How does LRS'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 Australian 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.