Estimating The Intrinsic Value Of Acadian Timber Corp. (TSE:ADN)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Acadian Timber fair value estimate is CA$14.80

• Current share price of CA$16.44 suggests Acadian Timber is potentially trading close to its fair value

• Our fair value estimate is 11% lower than Acadian Timber's analyst price target of CA$16.60

Today we will run through one way of estimating the intrinsic value of Acadian Timber Corp. (TSE:ADN) by taking the expected future cash flows and discounting them to their present 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 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. 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 Acadian Timber

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, 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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CA$, Millions)	CA$16.4m	CA$15.5m	CA$20.0m	CA$22.5m	CA$24.5m	CA$26.2m	CA$27.6m	CA$28.8m	CA$29.8m	CA$30.7m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x1	Est @ 12.26%	Est @ 9.12%	Est @ 6.92%	Est @ 5.39%	Est @ 4.31%	Est @ 3.56%	Est @ 3.03%
Present Value (CA$, Millions) Discounted @ 11%	CA$14.8	CA$12.5	CA$14.6	CA$14.8	CA$14.5	CA$14.0	CA$13.3	CA$12.5	CA$11.6	CA$10.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$133m

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 (1.8%) 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 11%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CA$31m× (1 + 1.8%) ÷ (11%– 1.8%) = CA$339m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$339m÷ ( 1 + 11%)¹⁰= CA$119m

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$252m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$16.4, the company appears around fair value at the time of writing. 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. 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 Acadian Timber 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 11%, which is based on a levered beta of 1.555. 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 Acadian Timber

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is well covered by earnings.

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

Weakness

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• Annual revenue is forecast to grow faster than the Canadian market.

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by cash flow.

• Annual earnings are forecast to decline for the next 3 years.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Acadian Timber, we've compiled three fundamental elements you should explore:

1. Risks: To that end, you should learn about the 3 warning signs we've spotted with Acadian Timber (including 1 which makes us a bit uncomfortable) .

2. Future Earnings: How does ADN'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.

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