A Look At The Intrinsic Value Of Northland Power Inc. (TSE:NPI)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Northland Power fair value estimate is CA$21.84

• With CA$21.92 share price, Northland Power appears to be trading close to its estimated fair value

• The CA$31.77 analyst price target for NPI is 45% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Northland Power Inc. (TSE:NPI) 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Northland Power

Is Northland Power Fairly Valued?

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$370.1m	CA$319.0m	CA$290.4m	CA$273.8m	CA$264.5m	CA$259.7m	CA$257.9m	CA$258.2m	CA$259.8m	CA$262.5m
Growth Rate Estimate Source	Analyst x3	Analyst x1	Est @ -8.97%	Est @ -5.70%	Est @ -3.41%	Est @ -1.81%	Est @ -0.69%	Est @ 0.10%	Est @ 0.65%	Est @ 1.03%
Present Value (CA$, Millions) Discounted @ 6.2%	CA$349	CA$283	CA$243	CA$215	CA$196	CA$181	CA$170	CA$160	CA$151	CA$144

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$2.1b

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 6.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$263m× (1 + 1.9%) ÷ (6.2%– 1.9%) = CA$6.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$6.3b÷ ( 1 + 6.2%)¹⁰= CA$3.5b

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$5.6b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$21.9, 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

Now 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 Northland Power 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 6.2%, which is based on a levered beta of 0.850. 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 Northland Power

Strength

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings declined over the past year.

• Interest payments on debt are not well covered.

• Dividend is low compared to the top 25% of dividend payers in the Renewable Energy market.

• Shareholders have been diluted in the past year.

Opportunity

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

• Good value based on P/E ratio compared to estimated Fair P/E ratio.

• Significant insider buying over the past 3 months.

Threat

• Debt is not well covered by operating cash flow.

• Annual earnings are forecast to grow slower than the Canadian market.

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for 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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Northland Power, we've compiled three important factors you should further examine:

1. Risks: To that end, you should learn about the 4 warning signs we've spotted with Northland Power (including 1 which is significant) .

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

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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.