Calculating The Fair Value Of Fab-Form Industries Ltd. (CVE:FBF)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Fab-Form Industries fair value estimate is CA$2.83

• Fab-Form Industries' CA$2.54 share price indicates it is trading at similar levels as its fair value estimate

• Peers of Fab-Form Industries are currently trading on average at a 11% premium

Today we will run through one way of estimating the intrinsic value of Fab-Form Industries Ltd. (CVE:FBF) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Fab-Form Industries

The Calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$1.13m	CA$1.17m	CA$1.20m	CA$1.23m	CA$1.26m	CA$1.29m	CA$1.32m	CA$1.35m	CA$1.37m	CA$1.40m
Growth Rate Estimate Source	Est @ 3.83%	Est @ 3.28%	Est @ 2.89%	Est @ 2.62%	Est @ 2.43%	Est @ 2.30%	Est @ 2.21%	Est @ 2.14%	Est @ 2.10%	Est @ 2.06%
Present Value (CA$, Millions) Discounted @ 6.5%	CA$1.1	CA$1.0	CA$1.0	CA$1.0	CA$0.9	CA$0.9	CA$0.8	CA$0.8	CA$0.8	CA$0.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$9.0m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$1.4m× (1 + 2.0%) ÷ (6.5%– 2.0%) = CA$32m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$32m÷ ( 1 + 6.5%)¹⁰= CA$17m

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$26m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$2.5, the company appears about fair value at a 10% 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

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 Fab-Form Industries 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 6.5%, which is based on a levered beta of 0.979. 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 Fab-Form Industries

Strength

• Currently debt free.

Weakness

• Earnings declined over the past year.

Opportunity

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

• Lack of analyst coverage makes it difficult to determine FBF's earnings prospects.

Threat

• No apparent threats visible for FBF.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Fab-Form Industries, there are three essential aspects you should look at:

1. Risks: As an example, we've found 3 warning signs for Fab-Form Industries that you need to consider before investing here.

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