Is There An Opportunity With Yangarra Resources Ltd.'s (TSE:YGR) 33% Undervaluation?

Key Insights

• The projected fair value for Yangarra Resources is CA$2.64 based on 2 Stage Free Cash Flow to Equity

• Yangarra Resources is estimated to be 33% undervalued based on current share price of CA$1.76

• Industry average discount to fair value of 29% suggests Yangarra Resources' peers are currently trading at a lower discount

In this article we are going to estimate the intrinsic value of Yangarra Resources Ltd. (TSE:YGR) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

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.

See our latest analysis for Yangarra 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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$26.6m	CA$22.0m	CA$21.6m	CA$21.4m	CA$21.4m	CA$21.5m	CA$21.7m	CA$22.0m	CA$22.3m	CA$22.6m
Growth Rate Estimate Source	Analyst x4	Analyst x1	Est @ -1.96%	Est @ -0.81%	Est @ -0.01%	Est @ 0.55%	Est @ 0.94%	Est @ 1.22%	Est @ 1.41%	Est @ 1.55%
Present Value (CA$, Millions) Discounted @ 9.9%	CA$24.2	CA$18.2	CA$16.2	CA$14.7	CA$13.3	CA$12.2	CA$11.2	CA$10.3	CA$9.5	CA$8.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$139m

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 9.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$23m× (1 + 1.9%) ÷ (9.9%– 1.9%) = CA$286m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$286m÷ ( 1 + 9.9%)¹⁰= CA$111m

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$250m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$1.8, the company appears quite good value at a 33% 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

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Yangarra 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 9.9%, which is based on a levered beta of 1.611. 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 Yangarra Resources

Strength

• Debt is not viewed as a risk.

Weakness

• Earnings declined over the past year.

• Shareholders have been diluted in the past year.

Opportunity

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

Threat

• No apparent threats visible for YGR.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. Can we work out why the company is trading at a discount to intrinsic value? For Yangarra Resources, there are three fundamental factors you should explore:

1. Risks: We feel that you should assess the 1 warning sign for Yangarra Resources we've flagged before making an investment in the company.

2. Future Earnings: How does YGR'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 TSX 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.