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Ag Growth International Inc.'s (TSE:AFN) Intrinsic Value Is Potentially 66% Above Its Share Price

How far off is Ag Growth International Inc. (TSE:AFN) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Ag Growth International

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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$123.3m

CA$148.3m

CA$170.0m

CA$163.0m

CA$159.4m

CA$157.8m

CA$157.4m

CA$158.0m

CA$159.2m

CA$160.8m

Growth Rate Estimate Source

Analyst x5

Analyst x3

Analyst x2

Analyst x1

Est @ -2.20%

Est @ -1.03%

Est @ -0.22%

Est @ 0.36%

Est @ 0.76%

Est @ 1.04%

Present Value (CA$, Millions) Discounted @ 11%

CA$111

CA$121

CA$125

CA$108

CA$95.7

CA$85.5

CA$77.0

CA$69.8

CA$63.5

CA$57.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$915m

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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CA$161m× (1 + 1.7%) ÷ (11%– 1.7%) = CA$1.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$1.8b÷ ( 1 + 11%)10= CA$650m

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$1.6b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CA$49.8, the company appears quite undervalued at a 40% 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.

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The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Ag Growth International 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 11%, which is based on a levered beta of 1.508. 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 Ag Growth International

Strength

  • No major strengths identified for AFN.

Weakness

  • Earnings declined over the past year.

  • Interest payments on debt are not well covered.

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

Opportunity

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

  • Good value based on P/S ratio and estimated fair value.

Threat

  • Debt is not well covered by operating cash flow.

  • Dividends are not covered by earnings.

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

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Ag Growth International, we've compiled three further aspects you should further research:

  1. Risks: Case in point, we've spotted 3 warning signs for Ag Growth International you should be aware of, and 1 of them shouldn't be ignored.

  2. Future Earnings: How does AFN'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 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!

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.

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