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Birchcliff Energy Ltd. (TSE:BIR) Shares Could Be 38% Below Their Intrinsic Value Estimate

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Birchcliff Energy fair value estimate is CA$8.64

  • Current share price of CA$5.35 suggests Birchcliff Energy is potentially 38% undervalued

  • Our fair value estimate is 29% higher than Birchcliff Energy's analyst price target of CA$6.71

Does the February share price for Birchcliff Energy Ltd. (TSE:BIR) 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. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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Check out our latest analysis for Birchcliff Energy

The Method

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 start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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 (CA$, Millions)

CA$132.0m

CA$149.1m

CA$145.3m

CA$143.6m

CA$143.2m

CA$143.9m

CA$145.2m

CA$147.0m

CA$149.1m

CA$151.5m

Growth Rate Estimate Source

Analyst x3

Analyst x4

Est @ -2.54%

Est @ -1.18%

Est @ -0.23%

Est @ 0.44%

Est @ 0.90%

Est @ 1.23%

Est @ 1.46%

Est @ 1.62%

Present Value (CA$, Millions) Discounted @ 7.6%

CA$123

CA$129

CA$117

CA$107

CA$99.3

CA$92.7

CA$86.9

CA$81.8

CA$77.1

CA$72.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$986m

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 (2.0%) 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 7.6%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$152m× (1 + 2.0%) ÷ (7.6%– 2.0%) = CA$2.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$2.8b÷ ( 1 + 7.6%)10= CA$1.3b

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 CA$2.3b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$5.4, the company appears quite undervalued at a 38% 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Birchcliff 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 1.219. 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 Birchcliff Energy

Strength

  • Debt is not viewed as a risk.

  • Dividend is in the top 25% of dividend payers in the market.

Weakness

  • Earnings declined over the past year.

Opportunity

  • Trading below our estimate of fair value by more than 20%.

  • Significant insider buying over the past 3 months.

Threat

  • Dividends are not covered by earnings and cashflows.

  • Annual revenue is expected to decline over the next 3 years.

Moving On:

Whilst important, the DCF calculation 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 Birchcliff Energy, there are three essential elements you should consider:

  1. Risks: For example, we've discovered 2 warning signs for Birchcliff Energy (1 doesn't sit too well with us!) that you should be aware of before investing here.

  2. Future Earnings: How does BIR'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. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.