An Intrinsic Calculation For Shaw Communications Inc. (TSE:SJR.B) Suggests It's 32% Undervalued

Today we will run through one way of estimating the intrinsic value of Shaw Communications Inc. (TSE:SJR.B) by estimating the company's future cash flows and discounting them to their present value. I will use 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 Shaw Communications

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2020	2021	2022	2023	2024	2025	2026	2027	2028	2029
Levered FCF (CA$, Millions)	CA$694.6m	CA$712.8m	CA$913.2m	CA$1.06b	CA$1.19b	CA$1.30b	CA$1.39b	CA$1.47b	CA$1.53b	CA$1.59b
Growth Rate Estimate Source	Analyst x10	Analyst x11	Analyst x2	Est @ 16.47%	Est @ 12.11%	Est @ 9.06%	Est @ 6.93%	Est @ 5.43%	Est @ 4.39%	Est @ 3.66%
Present Value (CA$, Millions) Discounted @ 7.8%	CA$644	CA$613	CA$729	CA$787	CA$818	CA$828	CA$821	CA$803	CA$777	CA$747

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$7.6b

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 10-year government bond rate of 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.8%.

Terminal Value (TV)= FCF₂₀₁₉ × (1 + g) ÷ (r – g) = CA$1.6b× (1 + 1.9%) ÷ 7.8%– 1.9%) = CA$28b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$28b÷ ( 1 + 7.8%)¹⁰= CA$13b

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$21b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$26.9, the company appears quite undervalued at a 32% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

TSX:SJR.B Intrinsic value, November 7th 2019

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 Shaw Communications 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 0.986. 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.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price to differ from the intrinsic value? For Shaw Communications, There are three further factors you should further examine:

1. Financial Health: Does SJR.B have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Future Earnings: How does SJR.B'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: Are there other high quality stocks you could be holding instead of SJR.B? 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 CA stock every day, so if you want to find the intrinsic value of any other stock just search here.

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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.