Key Insights

Using the 2 Stage Free Cash Flow to Equity, Altus Group fair value estimate is CA$55.91 Altus Group's CA$39.94 share price signals that it might be 29% undervalued Our fair value estimate is 6.3% higher than Altus Group's analyst price target of CA$52.61

Does the November share price for Altus Group Limited (TSE:AIF) 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 their present value. One way to achieve this is by employing 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.

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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Altus Group

The Method

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.

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) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (CA$, Millions)  CA$131.5m CA$138.0m CA$143.0m CA$147.5m CA$151.6m CA$155.5m CA$159.1m CA$162.6m CA$166.1m CA$169.6m Growth Rate Estimate Source Analyst x6 Analyst x2 Est @ 3.67% Est @ 3.15% Est @ 2.78% Est @ 2.53% Est @ 2.35% Est @ 2.22% Est @ 2.13% Est @ 2.07% Present Value (CA$, Millions) Discounted @ 7.5%  CA$122 CA$119 CA$115 CA$111 CA$106 CA$101 CA$96.0 CA$91.3 CA$86.7 CA$82.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$1.0b

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 7.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$170m× (1 + 1.9%) ÷ (7.5%– 1.9%) = CA$3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$3.1b÷ ( 1 + 7.5%)10= CA$1.5b

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 CA$2.5b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$39.9, the company appears a touch undervalued at a 29% 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

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Altus Group 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 1.111. 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 Altus Group

Strength

No major strengths identified for AIF.

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 Real Estate market.

Opportunity

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

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

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:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Altus Group, we've compiled three essential items you should assess:

Risks: Every company has them, and we've spotted  3 warning signs for Altus Group  (of which 1 is a bit unpleasant!) you should know about. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AIF's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors. 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.

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.