Advertisement
New Zealand markets closed
  • NZX 50

    12,105.29
    +94.63 (+0.79%)
     
  • NZD/USD

    0.5984
    -0.0022 (-0.37%)
     
  • NZD/EUR

    0.5536
    -0.0007 (-0.13%)
     
  • ALL ORDS

    8,153.70
    +80.10 (+0.99%)
     
  • ASX 200

    7,896.90
    +77.30 (+0.99%)
     
  • OIL

    82.55
    +1.20 (+1.48%)
     
  • GOLD

    2,234.70
    +22.00 (+0.99%)
     
  • NASDAQ

    18,268.35
    -12.50 (-0.07%)
     
  • FTSE

    7,968.57
    +36.59 (+0.46%)
     
  • Dow Jones

    39,778.16
    +18.08 (+0.05%)
     
  • DAX

    18,503.80
    +26.71 (+0.14%)
     
  • Hang Seng

    16,541.42
    +148.58 (+0.91%)
     
  • NIKKEI 225

    40,168.07
    -594.66 (-1.46%)
     
  • NZD/JPY

    90.3980
    -0.3820 (-0.42%)
     

Pan American Silver Corp. (TSE:PAAS) Shares Could Be 47% Below Their Intrinsic Value Estimate

Today we will run through one way of estimating the intrinsic value of Pan American Silver Corp. (TSE:PAAS) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Pan American Silver

What's The Estimated Valuation?

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. 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.

ADVERTISEMENT

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

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$228.0m

US$291.5m

US$338.7m

US$378.9m

US$412.3m

US$439.7m

US$462.5m

US$481.6m

US$498.0m

US$512.3m

Growth Rate Estimate Source

Analyst x3

Analyst x1

Est @ 16.21%

Est @ 11.85%

Est @ 8.8%

Est @ 6.67%

Est @ 5.18%

Est @ 4.13%

Est @ 3.4%

Est @ 2.89%

Present Value ($, Millions) Discounted @ 7.8%

US$212

US$251

US$271

US$281

US$284

US$281

US$274

US$265

US$254

US$242

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.6b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.7%) 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 7.8%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$512m× (1 + 1.7%) ÷ (7.8%– 1.7%) = US$8.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$8.6b÷ ( 1 + 7.8%)10= US$4.1b

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$6.7b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$22.6, the company appears quite good value at a 47% 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
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 Pan American Silver 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 7.8%, which is based on a levered beta of 1.092. 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.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Pan American Silver, we've put together three pertinent factors you should explore:

  1. Risks: Case in point, we've spotted 1 warning sign for Pan American Silver you should be aware of.

  2. Future Earnings: How does PAAS'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.

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