A Look At The Fair Value Of Tidewater Midstream and Infrastructure Ltd. (TSE:TWM)

Key Insights

• The projected fair value for Tidewater Midstream and Infrastructure is CA$1.04 based on 2 Stage Free Cash Flow to Equity

• Tidewater Midstream and Infrastructure's CA$1.03 share price indicates it is trading at similar levels as its fair value estimate

• Industry average discount to fair value of 26% suggests Tidewater Midstream and Infrastructure's peers are currently trading at a higher discount

Today we will run through one way of estimating the intrinsic value of Tidewater Midstream and Infrastructure Ltd. (TSE:TWM) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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 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 Tidewater Midstream and Infrastructure

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$131.6m	CA$81.0m	CA$56.6m	CA$45.0m	CA$38.8m	CA$35.2m	CA$33.2m	CA$32.0m	CA$31.4m	CA$31.2m
Growth Rate Estimate Source	Analyst x4	Analyst x2	Est @ -30.13%	Est @ -20.53%	Est @ -13.81%	Est @ -9.11%	Est @ -5.82%	Est @ -3.52%	Est @ -1.90%	Est @ -0.77%
Present Value (CA$, Millions) Discounted @ 12%	CA$118	CA$64.7	CA$40.4	CA$28.7	CA$22.1	CA$18.0	CA$15.1	CA$13.1	CA$11.5	CA$10.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$342m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$31m× (1 + 1.9%) ÷ (12%– 1.9%) = CA$317m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$317m÷ ( 1 + 12%)¹⁰= CA$103m

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 CA$445m. 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$1.0, the company appears about fair value at a 1.4% 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

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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Tidewater Midstream and Infrastructure 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 12%, which is based on a levered beta of 2.000. 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 Tidewater Midstream and Infrastructure

Strength

• Debt is well covered by cash flow.

Weakness

• Interest payments on debt are not well covered.

• Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.

Opportunity

• Expected to breakeven next year.

• Has sufficient cash runway for more than 3 years based on current free cash flows.

• Good value based on P/S ratio and estimated fair value.

Threat

• Paying a dividend but company is unprofitable.

Next Steps:

Whilst important, the DCF calculation 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. 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 Tidewater Midstream and Infrastructure, there are three important items you should assess:

1. Risks: For instance, we've identified 2 warning signs for Tidewater Midstream and Infrastructure that you should be aware of.

2. Future Earnings: How does TWM'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.

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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.