Paladin Energy Ltd (ASX:PDN) Shares Could Be 50% Below Their Intrinsic Value Estimate
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Paladin Energy fair value estimate is AU$2.36
Current share price of AU$1.19 suggests Paladin Energy is potentially 50% undervalued
Analyst price target for PDN is US$1.22 which is 48% below our fair value estimate
Does the January share price for Paladin Energy Ltd (ASX:PDN) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for Paladin Energy
The Model
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | -US$22.0m | US$143.5m | US$191.0m | US$227.1m | US$258.7m | US$285.4m | US$307.8m | US$326.7m | US$342.7m | US$356.6m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x2 | Est @ 18.92% | Est @ 13.87% | Est @ 10.33% | Est @ 7.86% | Est @ 6.12% | Est @ 4.91% | Est @ 4.06% |
Present Value ($, Millions) Discounted @ 7.6% | -US$20.5 | US$124 | US$153 | US$170 | US$180 | US$184 | US$185 | US$182 | US$178 | US$172 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.5b
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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$357m× (1 + 2.1%) ÷ (7.6%– 2.1%) = US$6.6b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$6.6b÷ ( 1 + 7.6%)10= US$3.2b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$4.7b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$1.2, 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
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 Paladin 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 7.6%, which is based on a levered beta of 1.097. 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 Paladin Energy
Strength
Debt is well covered by earnings.
Weakness
No major weaknesses identified for PDN.
Opportunity
Expected to breakeven next year.
Trading below our estimate of fair value by more than 20%.
Threat
Debt is not well covered by operating cash flow.
Has less than 3 years of cash runway based on current free cash flow.
Moving On:
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. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For Paladin Energy, we've put together three fundamental items you should look at:
Risks: You should be aware of the 1 warning sign for Paladin Energy we've uncovered before considering an investment in the company.
Future Earnings: How does PDN'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: 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. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock 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.
