How far off is Strathcona Resources Ltd. (TSE:SCR) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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, 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
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (CA$, Millions)
CA$716.0m
CA$468.5m
CA$372.6m
CA$321.7m
CA$293.2m
CA$276.9m
CA$268.1m
CA$263.9m
CA$262.9m
CA$263.9m
Growth Rate Estimate Source
Analyst x3
Analyst x2
Est @ -20.48%
Est @ -13.65%
Est @ -8.88%
Est @ -5.53%
Est @ -3.19%
Est @ -1.55%
Est @ -0.41%
Est @ 0.40%
Present Value (CA$, Millions) Discounted @ 7.6%
CA$666
CA$405
CA$299
CA$240
CA$203
CA$179
CA$161
CA$147
CA$136
CA$127
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CA$2.6b
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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$5.1b÷ ( 1 + 7.6%)10= CA$2.4b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CA$5.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$28.7, the company appears slightly overvalued at the time of writing. 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.
TSX:SCR Discounted Cash Flow January 23rd 2025
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Strathcona Resources 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 7.6%, which is based on a levered beta of 1.290. 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 Strathcona Resources
Strength
Earnings growth over the past year exceeded the industry.
Debt is well covered by earnings and cashflows.
Dividends are covered by earnings and cash flows.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Significant insider buying over the past 3 months.
Threat
Annual earnings are forecast to decline for the next 3 years.
Moving On:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a premium to intrinsic value? For Strathcona Resources, we've compiled three further elements you should assess:
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SCR's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
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.
