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Canadian Solar Inc.'s (NASDAQ:CSIQ) Intrinsic Value Is Potentially 26% Below Its Share Price

Key Insights

  • Canadian Solar's estimated fair value is US$28.14 based on 2 Stage Free Cash Flow to Equity

  • Canadian Solar's US$37.87 share price signals that it might be 35% overvalued

  • Analyst price target for CSIQ is US$47.29, which is 68% above our fair value estimate

In this article we are going to estimate the intrinsic value of Canadian Solar Inc. (NASDAQ:CSIQ) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. 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.

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Check out our latest analysis for Canadian Solar

Crunching The Numbers

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 begin with, we have to get estimates of 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

-US$653.0m

US$57.0m

-US$307.0m

US$256.0m

US$334.0m

US$393.0m

US$444.0m

US$487.1m

US$523.2m

US$553.6m

Growth Rate Estimate Source

Analyst x2

Analyst x1

Analyst x1

Analyst x1

Analyst x1

Est @ 17.66%

Est @ 12.98%

Est @ 9.71%

Est @ 7.42%

Est @ 5.81%

Present Value ($, Millions) Discounted @ 14%

-US$575

US$44.1

-US$209

US$154

US$176

US$182

US$181

US$175

US$166

US$154

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$449m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$554m× (1 + 2.1%) ÷ (14%– 2.1%) = US$4.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.9b÷ ( 1 + 14%)10= US$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 US$1.8b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$37.9, the company appears potentially overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
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. 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 Canadian Solar 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 14%, which is based on a levered beta of 1.948. 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 Canadian Solar

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is well covered by earnings.

Weakness

  • No major weaknesses identified for CSIQ.

Opportunity

  • Annual earnings are forecast to grow faster than the American market.

  • Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

  • Debt is not well covered by operating cash flow.

  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. What is the reason for the share price exceeding the intrinsic value? For Canadian Solar, we've compiled three essential aspects you should explore:

  1. Risks: Be aware that Canadian Solar is showing 1 warning sign in our investment analysis , you should know about...

  2. Future Earnings: How does CSIQ's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. 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 American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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