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A Look At The Intrinsic Value Of Canada Rare Earth Corp. (CVE:LL)

Key Insights

  • Canada Rare Earth's estimated fair value is CA$0.035 based on 2 Stage Free Cash Flow to Equity

  • Canada Rare Earth's CA$0.03 share price indicates it is trading at similar levels as its fair value estimate

In this article we are going to estimate the intrinsic value of Canada Rare Earth Corp. (CVE:LL) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

Check out our latest analysis for Canada Rare Earth

The Method

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 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.

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$339.7k

CA$370.7k

CA$396.5k

CA$418.1k

CA$436.5k

CA$452.5k

CA$466.7k

CA$479.6k

CA$491.7k

CA$503.3k

Growth Rate Estimate Source

Est @ 12.21%

Est @ 9.13%

Est @ 6.97%

Est @ 5.46%

Est @ 4.40%

Est @ 3.66%

Est @ 3.14%

Est @ 2.78%

Est @ 2.52%

Est @ 2.34%

Present Value (CA$, Millions) Discounted @ 7.5%

CA$0.3

CA$0.3

CA$0.3

CA$0.3

CA$0.3

CA$0.3

CA$0.3

CA$0.3

CA$0.3

CA$0.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$2.9m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (1.9%) 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 7.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$503k× (1 + 1.9%) ÷ (7.5%– 1.9%) = CA$9.1m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$9.1m÷ ( 1 + 7.5%)10= CA$4.4m

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$7.3m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$0.03, the company appears about fair value at a 13% 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
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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Canada Rare Earth 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 7.5%, which is based on a levered beta of 1.122. 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 Canada Rare Earth

Strength

  • Debt is well covered by earnings and cashflows.

Weakness

  • No major weaknesses identified for LL.

Opportunity

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

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

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

Threat

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

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for 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 Canada Rare Earth, we've put together three pertinent items you should assess:

  1. Risks: For example, we've discovered 4 warning signs for Canada Rare Earth (3 are concerning!) that you should be aware of before investing here.

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

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.