Does this assessment of Pollard Banknote Limited (TSE:PBL) imply that investors are paying too much?

In this article, we will estimate the intrinsic value of Pollard Banknote Limited (TSE:PBL) by taking the company’s expected future cash flows and discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.

Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.

See our latest analysis for Pollard Banknote

What is the estimated valuation?

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:

10-Year Free Cash Flow (FCF) Forecast

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Leveraged FCF (CA$, Millions)

CA$39.0m

C$37.3 million

C$36.4 million

C$35.9 million

C$35.7 million

C$35.7 million

C$35.9 million

C$36.2 million

C$36.6 million

C$37.1 million

Growth rate estimate Source

Analyst x3

East @ -4.4%

Is @ -2.61%

Is @ -1.36%

East @ -0.48%

Is at 0.13%

Is at 0.56%

Is at 0.86%

Is at 1.07%

Is at 1.22%

Present value (CA$, millions) discounted at 6.4%

CA$36.7

CA$32.9

CA$30.1

CA$27.9

CA$26.1

CA$24.6

CA$23.2

CA$22.0

CA$20.9

CA$19.8

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = 264 million Canadian dollars

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.6%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.4%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = C$37 million × (1 + 1.6%) ÷ (6.4%–1.6%) = C$771 million

Present value of terminal value (PVTV)= TV / (1 + r)ten= C$771m÷ (1 + 6.4%)ten= 413 million Canadian dollars

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is C$677 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of C$32.3, the company appears slightly overvalued at the time of writing. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

dcf

The hypotheses

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Pollard Banknote 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 takes debt into account. In this calculation, we used 6.4%, which is based on a leveraged beta of 1.152. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Let’s move on :

Although the valuation of a business is important, it will ideally not be the only piece of analysis you will look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. Can we understand why the company is trading at a premium to its intrinsic value? For Pollard Banknote, we have compiled three important aspects that you should consider in more detail:

  1. Risks: Be aware that Pollard Banknote displays 1 warning sign in our investment analysis you should know…

  2. Future earnings: How does PBL’s growth rate compare to its peers and the broader market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.

  3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

PS. The Simply Wall St app performs a daily updated cash flow valuation for each stock on the TSX. If you want to find the calculation for other stocks, search here.

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

Comments are closed.