Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Chorus Aviation Inc (
TSX:CHR) as an investment opportunity by projecting its future cash flows and then discounting them to today’s value. I will use the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the
Simply Wall St analysis model. Please also note that this article was written in May 2018 so be sure check out the updated calculation by following the link below.
View our latest analysis for Chorus Aviation The calculation
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow forecast
| | 2018 | 2019 | 2020 | 2021 | 2022 |
| Levered FCF (CA$, Millions) | CA$-370.00 | CA$211.00 | CA$-265.00 | CA$-16.00 | CA$249.00 |
| Source | Analyst x3 | Analyst x3 | Analyst x1 | Analyst x1 | Analyst x1 |
| Present Value Discounted @ 9.69% | CA$-337.32 | CA$175.38 | CA$-200.81 | CA$-11.05 | CA$156.83 |
Present Value of 5-year Cash Flow (PVCF)= CA$-217
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. 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 (2.1%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 9.7%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CA$249 × (1 + 2.1%) ÷ (9.7% – 2.1%) = CA$3,365
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CA$3,365 / ( 1 + 9.7%)5 = CA$2,120
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is CA$1,903. 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$13.83, which, compared to the current share price of CA$7.79, we find that Chorus Aviation is quite undervalued at a 43.66% discount to what it is available for right now.
TSX:CHR Intrinsic Value May 2nd 18 Important assumptions
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Chorus Aviation 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 9.7%, which is based on a levered beta of 0.96. 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:
Although the valuation of a company is important, 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 CHR, I’ve put together three essential aspects you should look at:
- Financial Health: Does CHR 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.
- Future Earnings: How does CHR’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of CHR? 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 TSX every 6 hours. If you want to find the calculation for other stocks just search here.
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