Is There An Opportunity With Chemtrade Logistics Income Fund's (TSE:CHE.UN) 44% Undervaluation?

Key Insights

  • The projected fair value for Chemtrade Logistics Income Fund is CA$16.01 based on 2 Stage Free Cash Flow to Equity

  • Chemtrade Logistics Income Fund is estimated to be 44% undervalued based on current share price of CA$8.93

  • The CA$11.79 analyst price target for CHE.UN is 26% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Chemtrade Logistics Income Fund (TSE:CHE.UN) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's 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.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Chemtrade Logistics Income Fund

What's The Estimated Valuation?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

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) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (CA$, Millions)

CA$173.5m

CA$168.7m

CA$166.4m

CA$165.7m

CA$166.1m

CA$167.3m

CA$169.0m

CA$171.2m

CA$173.6m

CA$176.3m

Growth Rate Estimate Source

Analyst x2

Est @ -2.74%

Est @ -1.38%

Est @ -0.42%

Est @ 0.24%

Est @ 0.71%

Est @ 1.04%

Est @ 1.27%

Est @ 1.43%

Est @ 1.54%

Present Value (CA$, Millions) Discounted @ 10%

CA$158

CA$139

CA$125

CA$113

CA$103

CA$93.8

CA$86.1

CA$79.2

CA$72.9

CA$67.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$1.0b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 10%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$176m× (1 + 1.8%) ÷ (10%– 1.8%) = CA$2.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$2.2b÷ ( 1 + 10%)10= CA$823m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CA$1.9b. 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$8.9, the company appears quite good value at a 44% 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
dcf

Important Assumptions

Now 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 Chemtrade Logistics Income Fund 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 1.400. 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 Chemtrade Logistics Income Fund

Strength

  • Debt is well covered by earnings and cashflows.

  • Dividends are covered by earnings and cash flows.

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

Weakness

  • Shareholders have been diluted in the past year.

Opportunity

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

Threat

  • Annual earnings are forecast to decline for the next 2 years.

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. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Chemtrade Logistics Income Fund, there are three pertinent items you should assess:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Chemtrade Logistics Income Fund (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CHE.UN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSX 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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here

Advertisement