Is Sherritt International Corporation (TSE:S) Expensive For A Reason? A Look At The Intrinsic Value

I am going to run you through how I calculated the intrinsic value of Sherritt International Corporation (TSE:S) by estimating the company’s future cash flows and discounting them to their present value. I will use the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for Sherritt International by following the link below. View out our latest analysis for Sherritt International

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. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow estimate

2018	2019	2020	2021	2022
Levered FCF (CA$, Millions)	CA$-36.73	CA$45.07	CA$49.95	CA$87.50	CA$66.00
Source	Analyst x3	Analyst x3	Analyst x2	Analyst x2	Analyst x1
Present Value Discounted @ 17.66%	CA$-31.22	CA$32.55	CA$30.67	CA$45.66	CA$29.27

Present Value of 5-year Cash Flow (PVCF)= CA$106.92m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.3%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 17.7%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = CA$66.00m × (1 + 2.3%) ÷ (17.7% – 2.3%) = CA$440.89m

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = CA$440.89m ÷ ( 1 + 17.7%)⁵ = CA$195.52m

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CA$302.44m. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of CA$0.76. Compared to the current share price of CA$1.12, the stock is quite expensive at the time of writing.

TSX:S Intrinsic Value June 27th 18

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Sherritt International as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 17.7%, which is based on a levered beta of 2. This is derived from the Bottom-Up Beta method based on 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. What is the reason for the share price to differ from the intrinsic value? For S, I’ve compiled three fundamental factors you should look at:

1. Financial Health: Does S 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 S’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 S? 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 for every stock on the TSE every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.