Does Polymetal International plc (LON: POLY) October share price reflect its true value? Today, we’re going to estimate the intrinsic value of the stock by projecting its future cash flows, then discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to do, although it might seem quite complex.
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. If you want to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St analysis model.
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Crunch the numbers
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. In the first step, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||686.6 million US dollars||US $ 703.0 million||US $ 499.0 million||US $ 814.0 million||US $ 831.2 million||US $ 845.7 million||US $ 858.3 million||US $ 869.6 million||US $ 880.0 million||US $ 889.7 million|
|Source of estimated growth rate||Analyst x5||Analyst x5||Analyst x1||Analyst x1||Est @ 2.11%||Is @ 1.75%||Est @ 1.49%||Est @ 1.32%||Est @ 1.19%||Is 1.1%|
|Present value (in millions of dollars) discounted at 8.4%||US $ 633||US $ 598||US $ 392||US $ 589||US $ 555||US $ 521||US $ 487||US $ 456||$ 425||US $ 396|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 5.1 billion
We now need to calculate the Terminal Value, which takes into account all 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 used the 5-year average of the 10-year government bond yield (0.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 8.4%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 890 million × (1 + 0.9%) ÷ (8.4% – 0.9%) = US $ 12 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 12 billion ÷ (1 + 8.4%)ten= US $ 5.3 billion
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is US $ 10 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of UK £ 13.6, the company appears to be roughly at fair value with a 15% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Polymetal International 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 takes into account debt. In this calculation, we used 8.4%, which is based on a leveraged beta of 1.207. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
While important, calculating DCF is just one of the many factors you need to assess for a business. DCF models are not the alpha and omega of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Polymetal International, there are three essential elements that you should consider further:
- Risks: For example, we discovered 2 warning signs for Polymetal International which you should know before investing here.
- Future benefits: How does POLY’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every share on the LSE. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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