Key Insights

The projected fair value for Sandstorm Gold is CA$6.28 based on 2 Stage Free Cash Flow to Equity Sandstorm Gold's CA$6.84 share price indicates it is trading at similar levels as its fair value estimate Analyst price target for SSL is US$9.65, which is 54% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Sandstorm Gold Ltd. (TSE:SSL) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. 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.

Check out our latest analysis for Sandstorm Gold

Is Sandstorm Gold Fairly Valued?

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. 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 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$116.6m US$131.0m US$98.5m US$93.6m US$90.9m US$89.6m US$89.3m US$89.5m US$90.2m US$91.2m Growth Rate Estimate Source Analyst x6 Analyst x5 Analyst x2 Est @ -4.92% Est @ -2.86% Est @ -1.43% Est @ -0.42% Est @ 0.29% Est @ 0.78% Est @ 1.12% Present Value ($, Millions) Discounted @ 8.0%  US$108 US$112 US$78.1 US$68.8 US$61.8 US$56.4 US$52.0 US$48.3 US$45.0 US$42.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$673m

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 8.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$91m× (1 + 1.9%) ÷ (8.0%– 1.9%) = US$1.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.5b÷ ( 1 + 8.0%)10= US$706m

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$1.4b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$6.8, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out. dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Sandstorm 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 8.0%, which is based on a levered beta of 1.218. 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 Sandstorm Gold

Strength

Debt is well covered by cash flow.

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 Metals and Mining market.

Expensive based on P/E ratio and estimated fair value.

Opportunity

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

Threat

Dividends are not covered by earnings.

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

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. 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. For Sandstorm Gold, we've compiled three important items you should further examine:

Risks: Every company has them, and we've spotted  2 warning signs for Sandstorm Gold  you should know about. Future Earnings: How does SSL'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 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. 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.

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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.