Yahoo Finance Is There An Opportunity With Leucrotta Exploration Inc.'s (CVE:LXE) 38% Undervaluation?
Today we will run through one way of estimating the intrinsic value of Leucrotta Exploration Inc. (CVE:LXE) by taking the expected future cash flows and discounting them to their present value. I will be using 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for Leucrotta Exploration
Is Leucrotta Exploration 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 start off with, we need to estimate 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.
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
2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | |
Levered FCF (CA$, Millions) | -CA$3.9m | CA$800.0k | CA$1.50m | CA$2.43m | CA$3.50m | CA$4.59m | CA$5.61m | CA$6.51m | CA$7.26m | CA$7.88m |
Growth Rate Estimate Source | Analyst x8 | Analyst x5 | Est @ 87.91% | Est @ 61.97% | Est @ 43.81% | Est @ 31.1% | Est @ 22.2% | Est @ 15.97% | Est @ 11.61% | Est @ 8.56% |
Present Value (CA$, Millions) Discounted @ 6.9% | -CA$3.6 | CA$0.7 | CA$1.2 | CA$1.9 | CA$2.5 | CA$3.1 | CA$3.5 | CA$3.8 | CA$4.0 | CA$4.0 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$21m
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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.
Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = CA$7.9m× (1 + 1.4%) ÷ 6.9%– 1.4%) = CA$147m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$147m÷ ( 1 + 6.9%)10= CA$75m
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$96m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$0.3, the company appears quite good value at a 38% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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 Leucrotta Exploration 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 6.9%, which is based on a levered beta of 1.002. 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 Leucrotta Exploration, We've compiled three important factors you should look at:
Risks: Take risks, for example - Leucrotta Exploration has 3 warning signs we think you should be aware of.
Future Earnings: How does LXE'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.
Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
