Estimating The Fair Value Of Targeted Microwave Solutions Inc. (CVE:TMS.H)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Targeted Microwave Solutions fair value estimate is CA$0.0043

• Targeted Microwave Solutions' CA$0.005 share price indicates it is trading at similar levels as its fair value estimate

• Industry average of 43% suggests Targeted Microwave Solutions' peers are currently trading at a higher premium to fair value

How far off is Targeted Microwave Solutions Inc. (CVE:TMS.H) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

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.

View our latest analysis for Targeted Microwave Solutions

What's The Estimated Valuation?

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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 ($, Millions)	US$4.4k	US$7.7k	US$11.6k	US$15.9k	US$20.1k	US$23.9k	US$27.3k	US$30.1k	US$32.4k	US$34.4k
Growth Rate Estimate Source	Est @ 103.47%	Est @ 73.01%	Est @ 51.69%	Est @ 36.76%	Est @ 26.31%	Est @ 19.00%	Est @ 13.88%	Est @ 10.29%	Est @ 7.78%	Est @ 6.03%
Present Value ($, Millions) Discounted @ 7.8%	US$0.004	US$0.007	US$0.009	US$0.01	US$0.01	US$0.02	US$0.02	US$0.02	US$0.02	US$0.02

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$126k

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$34k× (1 + 1.9%) ÷ (7.8%– 1.9%) = US$601k

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$601k÷ ( 1 + 7.8%)¹⁰= US$285k

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 US$411k. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$0.005, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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. 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 Targeted Microwave 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 7.8%, which is based on a levered beta of 1.166. 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 Targeted Microwave Solutions

Strength

• No major strengths identified for TMS.H.

Weakness

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

Opportunity

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

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

Threat

• Debt is not well covered by operating cash flow.

• Total liabilities exceed total assets, which raises the risk of financial distress.

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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 Targeted Microwave Solutions, we've compiled three essential items you should look at:

1. Risks: Take risks, for example - Targeted Microwave Solutions has 4 warning signs we think you should be aware of.

2. 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!

3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.