Is There An Opportunity With Alvopetro Energy Ltd.'s (CVE:ALV) 50% Undervaluation?
Key Insights
The projected fair value for Alvopetro Energy is CA$17.90 based on 2 Stage Free Cash Flow to Equity
Alvopetro Energy's CA$9.00 share price signals that it might be 50% undervalued
The US$13.00 analyst price target for ALV is 27% less than our estimate of fair value
Does the November share price for Alvopetro Energy Ltd. (CVE:ALV) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for Alvopetro Energy
The Method
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$46.1m | US$38.2m | US$33.9m | US$31.3m | US$29.9m | US$29.1m | US$28.7m | US$28.6m | US$28.7m | US$29.0m |
Growth Rate Estimate Source | Analyst x2 | Analyst x1 | Est @ -11.42% | Est @ -7.42% | Est @ -4.61% | Est @ -2.65% | Est @ -1.28% | Est @ -0.31% | Est @ 0.36% | Est @ 0.83% |
Present Value ($, Millions) Discounted @ 7.7% | US$42.8 | US$33.0 | US$27.1 | US$23.3 | US$20.7 | US$18.7 | US$17.2 | US$15.9 | US$14.8 | US$13.9 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$227m
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 7.7%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$29m× (1 + 1.9%) ÷ (7.7%– 1.9%) = US$517m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$517m÷ ( 1 + 7.7%)10= US$247m
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$474m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$9.0, the company appears quite good value at a 50% 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.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Alvopetro Energy 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 7.7%, which is based on a levered beta of 1.144. 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 Alvopetro Energy
Strength
Earnings growth over the past year exceeded the industry.
Currently debt free.
Dividends are covered by earnings and cash flows.
Dividend is in the top 25% of dividend payers in the market.
Weakness
No major weaknesses identified for ALV.
Opportunity
Annual earnings are forecast to grow faster than the Canadian market.
Good value based on P/E ratio and estimated fair value.
Threat
Annual revenue is forecast to grow slower than the Canadian market.
Moving On:
Although the valuation of a company is important, it is only one of many factors that you need to assess 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. 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 higher than the current share price? For Alvopetro Energy, we've compiled three important factors you should consider:
Risks: Be aware that Alvopetro Energy is showing 1 warning sign in our investment analysis , you should know about...
Future Earnings: How does ALV'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 TSXV 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.
