Key Insights
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Using the 2 Stage Free Cash Flow to Equity, Tamarack Valley Energy fair value estimate is CA$7.27
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Current share price of CA$3.65 suggests Tamarack Valley Energy is potentially 50% undervalued
In this article we are going to estimate the intrinsic value of Tamarack Valley Energy Ltd. (TSE:TVE) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
View our latest analysis for Tamarack Valley Energy
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
| | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 |
| Levered FCF (CA$, Millions) | CA$471.6m | CA$671.0m | CA$524.0m | CA$443.8m | CA$398.6m | CA$372.3m | CA$357.2m | CA$348.9m | CA$345.2m | CA$344.4m |
| Growth Rate Estimate Source | Analyst x7 | Analyst x1 | Analyst x1 | Est @ -15.31% | Est @ -10.18% | Est @ -6.59% | Est @ -4.07% | Est @ -2.31% | Est @ -1.08% | Est @ -0.21% |
| Present Value (CA$, Millions) Discounted @ 11% | CA$426 | CA$547 | CA$385 | CA$294 | CA$239 | CA$201 | CA$174 | CA$154 | CA$137 | CA$124 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$2.7b
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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 11%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$344m× (1 + 1.8%) ÷ (11%– 1.8%) = CA$3.9b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$3.9b÷ ( 1 + 11%)10= CA$1.4b
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$4.1b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$3.7, the company appears quite undervalued at a 50% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
dcf
Important Assumptions
Now 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 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 Tamarack Valley Energy 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 11%, which is based on a levered beta of 1.514. 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 Tamarack Valley Energy
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