Winpak Ltd.'s (TSE:WPK) Intrinsic Value Is Potentially 52% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Winpak fair value estimate is CA$60.90

• Current share price of CA$39.95 suggests Winpak is potentially 34% undervalued

• Our fair value estimate is 22% higher than Winpak's analyst price target of US$49.76

Today we will run through one way of estimating the intrinsic value of Winpak Ltd. (TSE:WPK) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Winpak

The Model

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. 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.

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 ($, Millions)	US$106.3m	US$111.6m	US$116.2m	US$120.1m	US$123.7m	US$126.9m	US$129.9m	US$132.8m	US$135.6m	US$138.4m
Growth Rate Estimate Source	Analyst x3	Est @ 5.02%	Est @ 4.08%	Est @ 3.41%	Est @ 2.95%	Est @ 2.62%	Est @ 2.39%	Est @ 2.23%	Est @ 2.12%	Est @ 2.04%
Present Value ($, Millions) Discounted @ 5.9%	US$100	US$99.6	US$97.9	US$95.6	US$93.0	US$90.2	US$87.2	US$84.2	US$81.2	US$78.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$908m

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 (1.9%) 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 5.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$138m× (1 + 1.9%) ÷ (5.9%– 1.9%) = US$3.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$3.5b÷ ( 1 + 5.9%)¹⁰= US$2.0b

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$2.9b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$40.0, the company appears quite undervalued at a 34% 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

We would point out that 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 Winpak 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 5.9%, which is based on a levered beta of 0.800. 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 Winpak

Strength

• Earnings growth over the past year exceeded the industry.

• Currently debt free.

Weakness

• Dividend is low compared to the top 25% of dividend payers in the Packaging market.

Opportunity

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

• Good value based on P/E ratio and estimated fair value.

Threat

• Annual earnings are 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 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 Winpak, we've put together three additional factors you should further examine:

1. Financial Health: Does WPK 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.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for WPK'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.

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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.