Calculating The Fair Value Of Coveo Solutions Inc. (TSE:CVO)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Coveo Solutions fair value estimate is CA$11.06

• Coveo Solutions' CA$9.60 share price indicates it is trading at similar levels as its fair value estimate

• Analyst price target for CVO is US$12.82, which is 16% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of Coveo Solutions Inc. (TSE:CVO) by taking the forecast future cash flows of the company and discounting them back 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

See our latest analysis for Coveo Solutions

Crunching The Numbers

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 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	-US$5.25m	US$7.50m	US$13.5m	US$21.0m	US$29.4m	US$37.8m	US$45.5m	US$52.3m	US$58.1m	US$62.9m
Growth Rate Estimate Source	Analyst x4	Analyst x2	Est @ 79.41%	Est @ 56.16%	Est @ 39.89%	Est @ 28.50%	Est @ 20.53%	Est @ 14.95%	Est @ 11.04%	Est @ 8.31%
Present Value ($, Millions) Discounted @ 6.9%	-US$4.9	US$6.6	US$11.0	US$16.1	US$21.0	US$25.3	US$28.5	US$30.6	US$31.8	US$32.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$198m

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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$63m× (1 + 1.9%) ÷ (6.9%– 1.9%) = US$1.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.3b÷ ( 1 + 6.9%)¹⁰= US$658m

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$856m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$9.6, the company appears about fair value at a 13% 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.

TSX:CVO Discounted Cash Flow January 1st 2024

The Assumptions

Now 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 Coveo Solutions 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 6.9%, which is based on a levered beta of 0.999. 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 Coveo Solutions

Strength

• Currently debt free.

Weakness

• No major weaknesses identified for CVO.

Opportunity

• Forecast to reduce losses next year.

• Has sufficient cash runway for more than 3 years based on current free cash flows.

• Current share price is below our estimate of fair value.

Threat

• Not expected to become profitable over the next 3 years.

Looking Ahead:

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. 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. For Coveo Solutions, there are three important items you should assess:

1. Risks: For instance, we've identified 1 warning sign for Coveo Solutions that you should be aware of.

2. Future Earnings: How does CVO'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

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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.