Calculating The Fair Value Of Tsodilo Resources Limited (CVE:TSD)

Key Insights

• The projected fair value for Tsodilo Resources is CA$0.23 based on 2 Stage Free Cash Flow to Equity

• With CA$0.21 share price, Tsodilo Resources appears to be trading close to its estimated fair value

• The average premium for Tsodilo Resources' competitorsis currently 40%

Today we will run through one way of estimating the intrinsic value of Tsodilo Resources Limited (CVE:TSD) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Tsodilo Resources

Step By Step Through The Calculation

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. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$136.9k	US$217.8k	US$309.1k	US$401.4k	US$487.7k	US$563.8k	US$628.5k	US$682.4k	US$727.3k	US$764.8k
Growth Rate Estimate Source	Est @ 83.59%	Est @ 59.07%	Est @ 41.91%	Est @ 29.89%	Est @ 21.48%	Est @ 15.60%	Est @ 11.48%	Est @ 8.59%	Est @ 6.57%	Est @ 5.16%
Present Value ($, Millions) Discounted @ 8.0%	US$0.1	US$0.2	US$0.2	US$0.3	US$0.3	US$0.4	US$0.4	US$0.4	US$0.4	US$0.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.0m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 8.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$765k× (1 + 1.9%) ÷ (8.0%– 1.9%) = US$13m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$13m÷ ( 1 + 8.0%)¹⁰= US$5.9m

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 US$8.9m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CA$0.2, the company appears about fair value at a 6.8% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Tsodilo 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 8.0%, which is based on a levered beta of 1.224. 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 Tsodilo Resources

Strength

• No major strengths identified for TSD.

Weakness

• Shareholders have been diluted in the past year.

Opportunity

• Has sufficient cash runway for more than 3 years based on current free cash flows.

• Current share price is below our estimate of fair value.

• Lack of analyst coverage makes it difficult to determine TSD's earnings prospects.

Threat

• Debt is not well covered by operating cash flow.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For Tsodilo Resources, we've put together three additional aspects you should further research:

1. Risks: Take risks, for example - Tsodilo Resources has 5 warning signs (and 4 which shouldn't be ignored) we think you should know about.

2. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSXV every day. If you want to find the calculation for other stocks 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.