Estimating The Fair Value Of GURU Organic Energy Corp. (TSE:GURU)

Key Insights

• GURU Organic Energy's estimated fair value is CA$2.42 based on 2 Stage Free Cash Flow to Equity

• Current share price of CA$2.05 suggests GURU Organic Energy is potentially trading close to its fair value

• The CA$3.75 analyst price target for GURU is 55% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of GURU Organic Energy Corp. (TSE:GURU) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for GURU Organic Energy

Is GURU Organic Energy 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 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.

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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	-CA$9.90m	-CA$3.56m	CA$962.0k	CA$1.50m	CA$2.09m	CA$2.68m	CA$3.23m	CA$3.71m	CA$4.12m	CA$4.47m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Est @ 55.64%	Est @ 39.57%	Est @ 28.32%	Est @ 20.45%	Est @ 14.94%	Est @ 11.08%	Est @ 8.38%
Present Value (CA$, Millions) Discounted @ 5.8%	-CA$9.4	-CA$3.2	CA$0.8	CA$1.2	CA$1.6	CA$1.9	CA$2.2	CA$2.4	CA$2.5	CA$2.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$2.6m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.1%) 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 5.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$4.5m× (1 + 2.1%) ÷ (5.8%– 2.1%) = CA$124m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$124m÷ ( 1 + 5.8%)¹⁰= CA$71m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CA$73m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$2.1, the company appears about fair value at a 15% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The 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 GURU Organic 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 5.8%, which is based on a levered beta of 0.800. 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 GURU Organic Energy

Strength

• Currently debt free.

Weakness

• No major weaknesses identified for GURU.

Opportunity

• Forecast to reduce losses next year.

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

• Significant insider buying over the past 3 months.

Threat

• Has less than 3 years of cash runway based on current free cash flow.

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

Moving On:

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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For GURU Organic Energy, we've compiled three relevant aspects you should further research:

1. Risks: Every company has them, and we've spotted 2 warning signs for GURU Organic Energy you should know about.

2. Future Earnings: How does GURU'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. 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.

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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.

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