Key Insights

Ramelius Resources' estimated fair value is AU$1.43 based on 2 Stage Free Cash Flow to Equity Current share price of AU$1.40 suggests Ramelius Resources is potentially trading close to its fair value Analyst price target for RMS is AU$1.63, which is 14% above our fair value estimate

In this article we are going to estimate the intrinsic value of Ramelius Resources Limited (ASX:RMS) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Ramelius Resources

Is Ramelius Resources Fairly Valued?

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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 (A$, Millions)  AU$213.2m AU$233.5m AU$81.8m AU$81.8m AU$82.4m AU$83.3m AU$84.4m AU$85.7m AU$87.2m AU$88.7m Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x2 Est @ 0.11% Est @ 0.68% Est @ 1.08% Est @ 1.36% Est @ 1.55% Est @ 1.69% Est @ 1.79% Present Value (A$, Millions) Discounted @ 7.6%  AU$198 AU$202 AU$65.6 AU$61.0 AU$57.1 AU$53.6 AU$50.5 AU$47.6 AU$45.0 AU$42.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$822m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$89m× (1 + 2.0%) ÷ (7.6%– 2.0%) = AU$1.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$1.6b÷ ( 1 + 7.6%)10= AU$772m

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 AU$1.6b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$1.4, the company appears about fair value at a 2.3% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind. dcf

Important 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 Ramelius 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 1.124. 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 Ramelius Resources

Strength

Earnings growth over the past year exceeded the industry.

Currently debt free.

Weakness

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

Shareholders have been diluted in the past year.

Opportunity

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

Current share price is below our estimate of fair value.

Threat

Annual revenue is expected to decline over the next 3 years.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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 Ramelius Resources, we've compiled three important factors you should assess:

Risks: Case in point, we've spotted  1 warning sign for Ramelius Resources you should be aware of. Future Earnings: How does RMS'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. 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.