Diversified Royalty Corp T.DIV

Alternate Symbol(s): T.DIV.DB.A | BEVFF

Consumer Cyclical Auto & Truck Dealerships

Diversified Royalty Corp. is a multi-royalty company. The Company is engaged in acquiring royalties from multi-location businesses and franchisors in North America. It owns Mr. Lube + Tires, AIR MILES, Sutton, Mr. Mikes, Nurse Next Door, Oxford Learning Centres, Stratus Building Solutions and BarBurrito trademarks. Mr. Lube + Tires is the quick lube service business in Canada, with locations across Canada. AIR MILES is a coalition loyalty program. Sutton is a residential real estate brokerage franchisor business in Canada. Mr. Mikes operates casual steakhouse restaurants in western Canadian communities. Nurse Next Door is a home care provider. Oxford Learning Centres is a franchisee supplemental education service. Stratus Building Solutions is a commercial cleaning service franchise company providing comprehensive environmentally friendly janitorial, building cleaning, and office cleaning services in the United States. BarBurrito is a quick-service Mexican restaurant food chain.

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Diversified Royalty Corp > DIV could Be 48% Below Intrinsic Value.

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Post by kijijion Aug 25, 2023 9:32am

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Post# 35605101

DIV could Be 48% Below Intrinsic Value.

Key Insights

Diversified Royalty's estimated fair value is CA$5.39 based on 2 Stage Free Cash Flow to Equity
Diversified Royalty is estimated to be 48% undervalued based on current share price of CA$2.81
Price target $3.99 which is 26% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Diversified Royalty Corp. (TSE:DIV) as an investment opportunity by estimating the company's future cash flows and discounting them to their present 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.

The Calculation

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$39.9m	CA$41.7m	CA$45.6m	CA$48.0m	CA$49.9m	CA$51.5m	CA$52.9m	CA$54.3m	CA$55.6m	CA$56.8m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Analyst x1	Est @ 3.86%	Est @ 3.26%	Est @ 2.84%	Est @ 2.55%	Est @ 2.34%	Est @ 2.20%
Present Value (CA$, Millions) Discounted @ 7.9%	CA$37.0	CA$35.8	CA$36.3	CA$35.4	CA$34.1	CA$32.6	CA$31.1	CA$29.5	CA$28.0	CA$26.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$326m

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$57m× (1 + 1.9%) ÷ (7.9%– 1.9%) = CA$955m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$955m÷ ( 1 + 7.9%)10= CA$446m

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$772m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$2.8, the company appears quite undervalued at a 48% 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.

The 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 these inputs, I recommend redoing the calculations yourself and playing with them. 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 Diversified Royalty 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 7.9%, which is based on a levered beta of 1.211. 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.