Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Kraken Robotics Inc. (CVE:PNG) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (CA$, Millions)
CA$15.2m
CA$16.7m
CA$18.5m
CA$23.6m
CA$26.2m
CA$28.3m
CA$30.1m
CA$31.6m
CA$33.0m
CA$34.1m
Growth Rate Estimate Source
Analyst x2
Analyst x1
Analyst x1
Analyst x1
Est @ 10.84%
Est @ 8.21%
Est @ 6.37%
Est @ 5.08%
Est @ 4.18%
Est @ 3.55%
Present Value (CA$, Millions) Discounted @ 7.1%
CA$14.2
CA$14.5
CA$15.0
CA$17.9
CA$18.5
CA$18.7
CA$18.6
CA$18.2
CA$17.7
CA$17.1
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CA$171m
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. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$687m÷ ( 1 + 7.1%)10= CA$345m
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$515m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$1.2, the company appears quite good value at a 48% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
TSXV:PNG Discounted Cash Flow July 12th 2024
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 Kraken Robotics 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 7.1%, which is based on a levered beta of 1.102. 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 Kraken Robotics
Strength
Debt is not viewed as a risk.
Weakness
Shareholders have been diluted in the past year.
Opportunity
Annual earnings are forecast to grow faster than the Canadian market.
Trading below our estimate of fair value by more than 20%.
Threat
Revenue is forecast to grow slower than 20% per year.
Moving On:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Kraken Robotics, we've compiled three relevant factors you should consider:
Future Earnings: How does PNG'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. 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.
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