- The projected fair value for SilverCrest Metals is CA$7.69 based on 2 Stage Free Cash Flow to Equity
- SilverCrest Metals’ CA$6.54 share price indicates it is trading at similar levels as its fair value estimate
- The US$9.08 analyst price target for SIL is 18% more than our estimate of fair value
Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of SilverCrest Metals Inc. (TSE:SIL) as an investment opportunity by taking the expected future cash flows and discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
We generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
View our latest analysis for SilverCrest Metals
What’s The Estimated Valuation?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$55.4m||US$49.0m||US$48.4m||US$48.2m||US$48.4m||US$48.8m||US$49.3m||US$50.0m||US$50.7m||US$51.6m|
|Growth Rate Estimate Source||Analyst x5||Analyst x3||Analyst x3||Est @ -0.30%||Est @ 0.35%||Est @ 0.80%||Est @ 1.12%||Est @ 1.34%||Est @ 1.50%||Est @ 1.61%|
|Present Value ($, Millions) Discounted @ 7.3%||US$51.6||US$42.6||US$39.2||US$36.4||US$34.1||US$32.0||US$30.2||US$28.5||US$27.0||US$25.6|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$347m
The second stage is also known as Terminal Value, this is the business’s cash flow after 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 1.9%. We discount the terminal cash flows to today’s value at a cost of equity of 7.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$52m× (1 + 1.9%) ÷ (7.3%– 1.9%) = US$971m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$971m÷ ( 1 + 7.3%)10= US$481m
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$828m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$6.5, the company appears about fair value at a 15% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 SilverCrest Metals 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 7.3%, which is based on a levered beta of 1.082. 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 SilverCrest Metals
- No major weaknesses identified for SIL.
- Annual revenue is forecast to grow faster than the Canadian market.
- Current share price is below our estimate of fair value.
- Annual earnings are forecast to decline for the next 3 years.
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It’s not possible to obtain a foolproof valuation with a DCF model. 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. For SilverCrest Metals, there are three important elements you should consider:
- Risks: Take risks, for example – SilverCrest Metals has 1 warning sign we think you should be aware of.
- Future Earnings: How does SIL’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.
- 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.
Valuation is complex, but we’re helping make it simple.
Find out whether SilverCrest Metals is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.