A Look At The Intrinsic Value Of Ramaco Resources, Inc. (NASDAQ:METC)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Ramaco Resources fair value estimate is US$8.13

• With US$9.06 share price, Ramaco Resources appears to be trading close to its estimated fair value

• Analyst price target for METC is US$9.66, which is 19% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Ramaco Resources, Inc. (NASDAQ:METC) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Ramaco Resources

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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$62.7m	US$32.1m	US$30.4m	US$29.4m	US$28.9m	US$28.8m	US$28.9m	US$29.1m	US$29.5m	US$29.9m
Growth Rate Estimate Source	Analyst x3	Analyst x2	Est @ -5.41%	Est @ -3.15%	Est @ -1.57%	Est @ -0.47%	Est @ 0.30%	Est @ 0.85%	Est @ 1.23%	Est @ 1.49%
Present Value ($, Millions) Discounted @ 10%	US$57.0	US$26.5	US$22.8	US$20.1	US$17.9	US$16.2	US$14.8	US$13.6	US$12.5	US$11.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$213m

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$30m× (1 + 2.1%) ÷ (10%– 2.1%) = US$386m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$386m÷ ( 1 + 10%)¹⁰= US$148m

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 US$361m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$9.1, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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 Ramaco 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 10%, which is based on a levered beta of 1.334. 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 Ramaco Resources

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is not viewed as a risk.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• Earnings growth over the past year is below its 5-year average.

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• METC's financial characteristics indicate limited near-term opportunities for shareholders.

Threat

• Paying a dividend but company has no free cash flows.

• Annual earnings are forecast to decline for the next 3 years.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Ramaco Resources, there are three further aspects you should assess:

1. Risks: Be aware that Ramaco Resources is showing 4 warning signs in our investment analysis , and 2 of those are potentially serious...

2. Future Earnings: How does METC'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks 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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