Estimating The Intrinsic Value Of Trican Well Service Ltd. (TSE:TCW)

Key Insights

• Trican Well Service's estimated fair value is CA$4.24 based on 2 Stage Free Cash Flow to Equity

• With CA$4.82 share price, Trican Well Service appears to be trading close to its estimated fair value

• The CA$5.53 analyst price target for TCW is 31% more than our estimate of fair value

How far off is Trican Well Service Ltd. (TSE:TCW) 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 today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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.

View our latest analysis for Trican Well Service

Crunching The Numbers

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CA$, Millions)	CA$89.0m	CA$124.2m	CA$108.6m	CA$66.0m	CA$67.0m	CA$56.4m	CA$50.6m	CA$47.2m	CA$45.3m	CA$44.3m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x2	Analyst x1	Analyst x1	Est @ -15.76%	Est @ -10.41%	Est @ -6.66%	Est @ -4.04%	Est @ -2.20%
Present Value (CA$, Millions) Discounted @ 8.0%	CA$82.4	CA$106	CA$86.2	CA$48.5	CA$45.6	CA$35.6	CA$29.5	CA$25.5	CA$22.6	CA$20.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$503m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.1%) 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 8.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CA$44m× (1 + 2.1%) ÷ (8.0%– 2.1%) = CA$763m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$763m÷ ( 1 + 8.0%)¹⁰= CA$353m

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$856m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$4.8, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Trican Well Service 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 1.288. 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 Trican Well Service

Strength

• Currently debt free.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings growth over the past year underperformed the Energy Services industry.

• Dividend is low compared to the top 25% of dividend payers in the Energy Services market.

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• TCW's financial characteristics indicate limited near-term opportunities for shareholders.

Threat

• Annual earnings are forecast to decline for the next 3 years.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Trican Well Service, we've put together three additional aspects you should consider:

1. Risks: For example, we've discovered 2 warning signs for Trican Well Service (1 is concerning!) that you should be aware of before investing here.

2. Future Earnings: How does TCW'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSX every day. If you want to find the calculation for other stocks 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.

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