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Is There An Opportunity With Osisko Gold Royalties Ltd's (TSE:OR) 30% Undervaluation?

Does the May share price for Osisko Gold Royalties Ltd (TSE:OR) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the foreast future cash flows of the company and discounting them back to today's 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.

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.

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View our latest analysis for Osisko Gold Royalties

What's the estimated valuation?

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. 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.

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Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

Levered FCF (CA$, Millions)

CA$52.35

CA$107.18

CA$145.28

CA$176.84

CA$204.76

CA$228.59

CA$248.55

CA$265.19

CA$279.17

CA$291.10

Growth Rate Estimate Source

Analyst x5

Analyst x8

Analyst x5

Est @ 21.72%

Est @ 15.79%

Est @ 11.64%

Est @ 8.73%

Est @ 6.7%

Est @ 5.27%

Est @ 4.27%

Present Value (CA$, Millions) Discounted @ 8.91%

CA$48.07

CA$90.37

CA$112.47

CA$125.71

CA$133.66

CA$137.01

CA$136.79

CA$134.02

CA$129.55

CA$124.04

Present Value of 10-year Cash Flow (PVCF)= CA$1.17b

"Est" = FCF growth rate estimated by Simply Wall St

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 8.9%.

Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = CA$291m × (1 + 1.9%) ÷ (8.9% – 1.9%) = CA$4.3b

Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = CA$CA$4.3b ÷ ( 1 + 8.9%)10 = CA$1.82b

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$2.99b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value estimate of CA$19.26. Relative to the current share price of CA$13.58, the company appears a touch undervalued at a 30% 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.

TSX:OR Intrinsic value, May 17th 2019
TSX:OR Intrinsic value, May 17th 2019

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Osisko Gold Royalties 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 8.9%, which is based on a levered beta of 1.168. 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:

Although the valuation of a company is important, 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 Osisko Gold Royalties, I've put together three pertinent factors you should look at:

  1. Financial Health: Does OR 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 OR'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 OR? 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.

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.

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.