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An Intrinsic Calculation For First Quantum Minerals Ltd. (TSE:FM) Suggests It's 29% Undervalued

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of First Quantum Minerals Ltd. (TSE:FM) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

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.

See our latest analysis for First Quantum Minerals

Is First Quantum Minerals fairly valued?

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. To begin with, we have to get estimates of 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

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Levered FCF ($, Millions)

US$881.8m

US$1.06b

US$910.6m

US$983.1m

US$999.3m

US$1.02b

US$1.03b

US$1.05b

US$1.07b

US$1.08b

Growth Rate Estimate Source

Analyst x11

Analyst x11

Analyst x5

Analyst x3

Est @ 1.65%

Est @ 1.65%

Est @ 1.66%

Est @ 1.66%

Est @ 1.66%

Est @ 1.66%

Present Value ($, Millions) Discounted @ 12%

US$785

US$836

US$641

US$616

US$557

US$504

US$456

US$412

US$373

US$337

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$5.5b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 (1.7%) 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 12%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$1.1b× (1 + 1.7%) ÷ (12%– 1.7%) = US$10b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$10b÷ ( 1 + 12%)10= US$3.2b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$8.7b. 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$11.9, the company appears a touch undervalued at a 29% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
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 First Quantum Minerals 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 12%, which is based on a levered beta of 1.787. 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.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For First Quantum Minerals, there are three fundamental aspects you should explore:

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

  2. Future Earnings: How does FM'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 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.

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. 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.

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