Key Insights

Using the 2 Stage Free Cash Flow to Equity, Equinox Gold fair value estimate is CA$8.99 Equinox Gold is estimated to be 31% undervalued based on current share price of CA$6.21 Analyst price target for EQX is US$8.12 which is 9.7% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Equinox Gold Corp. (TSE:EQX) as an investment opportunity by estimating the company's 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Equinox Gold

Is Equinox 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 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:



10-year free cash flow (FCF) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF ($, Millions)  -US$120.1m US$57.2m US$85.1m US$114.6m US$143.1m US$168.7m US$190.9m US$209.5m US$224.9m US$237.8m Growth Rate Estimate Source Analyst x6 Analyst x5 Est @ 48.72% Est @ 34.66% Est @ 24.82% Est @ 17.93% Est @ 13.11% Est @ 9.74% Est @ 7.37% Est @ 5.72% Present Value ($, Millions) Discounted @ 9.1%  -US$110 US$48.1 US$65.5 US$80.8 US$92.5 US$99.9 US$104 US$104 US$102 US$99.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$686m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 (1.9%) 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 9.1%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$238m× (1 + 1.9%) ÷ (9.1%– 1.9%) = US$3.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.3b÷ ( 1 + 9.1%)10= US$1.4b

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$2.1b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$6.2, the company appears quite good value at a 31% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent. dcf

Important 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 Equinox 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 9.1%, which is based on a levered beta of 1.454. 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 Equinox Gold

Strength

Earnings growth over the past year exceeded the industry.

Debt is well covered by cash flow.

Weakness

Interest payments on debt are not well covered.

Shareholders have been diluted in the past year.

Opportunity

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

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

Threat

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

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Equinox Gold, there are three fundamental factors you should consider:

Risks: We feel that you should assess the 2 warning signs for Equinox Gold we've flagged before making an investment in the company. Future Earnings: How does EQX'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. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of any other stock 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.