A Look At The Intrinsic Value Of Dollarama Inc. (TSE:DOL)

Key Insights

• Dollarama's estimated fair value is CA$86.16 based on 2 Stage Free Cash Flow to Equity

• Dollarama's CA$76.50 share price indicates it is trading at similar levels as its fair value estimate

• Analyst price target for DOL is CA$89.86, which is 4.3% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of Dollarama Inc. (TSE:DOL) by estimating the company's future cash flows and discounting them to their present 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!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Dollarama

The Calculation

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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CA$, Millions)	CA$675.6m	CA$940.6m	CA$1.07b	CA$1.17b	CA$1.25b	CA$1.31b	CA$1.37b	CA$1.41b	CA$1.46b	CA$1.49b
Growth Rate Estimate Source	Analyst x6	Analyst x6	Analyst x3	Est @ 8.89%	Est @ 6.75%	Est @ 5.26%	Est @ 4.21%	Est @ 3.47%	Est @ 2.96%	Est @ 2.60%
Present Value (CA$, Millions) Discounted @ 6.7%	CA$633	CA$827	CA$883	CA$901	CA$902	CA$889	CA$869	CA$843	CA$813	CA$782

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$8.3b

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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CA$1.5b× (1 + 1.8%) ÷ (6.7%– 1.8%) = CA$31b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$31b÷ ( 1 + 6.7%)¹⁰= CA$16b

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$25b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$76.5, the company appears about fair value at a 11% discount to where the stock price trades currently. 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Dollarama 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 6.7%, which is based on a levered beta of 0.829. 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 Dollarama

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is well covered by earnings and cashflows.

Weakness

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

Opportunity

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

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

Threat

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

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. For Dollarama, we've compiled three important items you should consider:

1. Risks: Case in point, we've spotted 2 warning signs for Dollarama you should be aware of.

2. Future Earnings: How does DOL'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 Canadian 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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here