PFB Corporation (TSE:PFB) Is Trading At A 24.78% Discount
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How far off is PFB Corporation (TSE:PFB) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by estimating the company’s future cash flows and discounting them to their present value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in February 2019 so be sure check out the updated calculation by following the link below.
See our latest analysis for PFB
The method
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 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. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF (CA$, Millions) | CA$8.37 | CA$8.84 | CA$9.40 | CA$9.99 | CA$10.62 |
Source | Analyst x2 | Analyst x1 | Est @ 6.31% | Est @ 6.31% | Est @ 6.31% |
Present Value Discounted @ 12.59% | CA$7.43 | CA$6.97 | CA$6.58 | CA$6.22 | CA$5.87 |
Present Value of 5-year Cash Flow (PVCF)= CA$33m
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (1.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 12.6%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = CA$11m × (1 + 1.9%) ÷ (12.6% – 1.9%) = CA$102m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CA$102m ÷ ( 1 + 12.6%)5 = CA$56m
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$89m. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of CA$13.29. Relative to the current share price of CA$10, the stock is about right, perhaps slightly undervalued at a 25% discount to what it is available for right now.
Important assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 PFB 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 12.6%, which is based on a levered beta of 1.322. 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.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and 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 PFB, I’ve put together three key aspects you should look at:
Financial Health: Does PFB 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 PFB’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 PFB? 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 for every stock on the TSE every 6 hours. If you want to find the calculation for other stocks just search here.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. On rare occasion, data errors may occur. Thank you for reading.
