In this article I am going to calculate the intrinsic value of Major Drilling Group International Inc (TSE:MDI) by taking the expected future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in December 2018 so be sure check out the updated calculation by following the link below.
What’s the value?
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
|Levered FCF (CA$, Millions)||CA$20.45||CA$49.90||CA$53.90||CA$50.37||CA$47.06|
|Source||Analyst x2||Analyst x2||Analyst x1||Est @ -6.56%||Est @ -6.56%|
|Present Value Discounted @ 15.28%||CA$17.74||CA$37.55||CA$35.19||CA$28.52||CA$23.12|
Present Value of 5-year Cash Flow (PVCF)= CA$142m
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 an annual growth rate equal to the 10-year government bond rate of 2.3%. We discount this to today’s value at a cost of equity of 15.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CA$47m × (1 + 2.3%) ÷ (15.3% – 2.3%) = CA$372m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CA$372m ÷ ( 1 + 15.3%)5 = CA$183m
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is CA$325m. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of CA$4.05. Relative to the current share price of CA$5.01, the stock is fair value, maybe slightly overvalued at the time of writing.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Major Drilling Group International as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 15.3%, which is based on a levered beta of 1.689. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For MDI, there are three essential aspects you should further research:
- Financial Health: Does MDI have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does MDI’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of MDI? 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 does a DCF calculation for every CA stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.