Key Insights

Using the 2 Stage Free Cash Flow to Equity, Northern Star Resources fair value estimate is AU$17.63 Current share price of AU$11.54 suggests Northern Star Resources is potentially 35% undervalued Our fair value estimate is 34% higher than Northern Star Resources' analyst price target of AU$13.13

In this article we are going to estimate the intrinsic value of Northern Star Resources Limited (ASX:NST) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Northern Star Resources

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:



10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (A$, Millions)  AU$449.3m AU$1.31b AU$1.05b AU$1.45b AU$1.38b AU$1.35b AU$1.34b AU$1.34b AU$1.35b AU$1.36b Growth Rate Estimate Source Analyst x4 Analyst x2 Analyst x4 Analyst x2 Analyst x1 Est @ -2.19% Est @ -0.91% Est @ -0.01% Est @ 0.61% Est @ 1.05% Present Value (A$, Millions) Discounted @ 7.6%  AU$417 AU$1.1k AU$841 AU$1.1k AU$958 AU$870 AU$801 AU$745 AU$696 AU$654

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$8.2b

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 (2.1%) 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 7.6%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$1.4b× (1 + 2.1%) ÷ (7.6%– 2.1%) = AU$25b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$25b÷ ( 1 + 7.6%)10= AU$12b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$20b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$11.5, the company appears quite undervalued at a 35% 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

The 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 Northern Star Resources 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 7.6%, which is based on a levered beta of 1.109. 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 Northern Star Resources

Strength

Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk.

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 Australian market.

Trading below our estimate of fair value by more than 20%.

Threat

Dividends are not covered by cash flow.

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

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for 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?" 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 Northern Star Resources, we've compiled three relevant items you should explore:

Risks: Take risks, for example - Northern Star Resources has  1 warning sign  we think you should be aware of. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for NST's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors. 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. Simply Wall St updates its DCF calculation for every Australian 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.