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A Look At The Intrinsic Value Of Lundin Gold Inc. (TSE:LUG)

Key Insights

  • Lundin Gold's estimated fair value is CA$19.77 based on 2 Stage Free Cash Flow to Equity

  • Current share price of CA$18.88 suggests Lundin Gold is potentially trading close to its fair value

  • Analyst price target for LUG is US$24.10, which is 22% above our fair value estimate

Does the June share price for Lundin Gold Inc. (TSE:LUG) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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View our latest analysis for Lundin Gold

Step By Step Through The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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 ($, Millions)

US$375.9m

US$423.0m

US$407.5m

US$219.1m

US$246.1m

US$209.4m

US$188.9m

US$177.1m

US$170.5m

US$167.1m

Growth Rate Estimate Source

Analyst x12

Analyst x12

Analyst x8

Analyst x1

Analyst x1

Est @ -14.91%

Est @ -9.81%

Est @ -6.24%

Est @ -3.75%

Est @ -2.00%

Present Value ($, Millions) Discounted @ 7.5%

US$350

US$366

US$328

US$164

US$172

US$136

US$114

US$99.7

US$89.3

US$81.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.9b

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$167m× (1 + 2.1%) ÷ (7.5%– 2.1%) = US$3.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.2b÷ ( 1 + 7.5%)10= US$1.5b

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$3.4b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$18.9, the company appears about fair value at a 4.5% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

The Assumptions

We would point out that 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 Lundin Gold 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 7.5%, which is based on a levered beta of 1.168. 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 Lundin Gold

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is not viewed as a risk.

  • Dividends are covered by earnings and cash flows.

Weakness

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

Opportunity

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

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

Threat

  • Annual revenue is forecast to grow slower than the Canadian market.

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. For Lundin Gold, we've compiled three fundamental elements you should look at:

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

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for LUG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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.

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