Is there an opportunity with the 44% undervaluation of Yellow Pages Limited (TSE:Y)?

Today we are going to do a simple walkthrough of a valuation method used to estimate the attractiveness of Yellow Pages Limited (TSE:Y) as an investment opportunity by estimating the future cash flows of company and discounting them to their current value. On this occasion, we will use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it may seem quite complex.

Remember though that there are many ways to estimate the value of a business and a DCF is just one method. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.

See our latest analysis for the Yellow Pages

Step by step in the calculation

We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

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

Estimated free cash flow (FCF) over 10 years

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Leveraged FCF (CA$, Millions)

C$47.6 million

C$52.8 million

CA$46.0m

C$42.1 million

C$39.9 million

38.5 million Canadian dollars

C$37.8 million

37.5 million Canadian dollars

37.5 million Canadian dollars

C$37.6 million

Growth rate estimate Source

Analyst x2

Analyst x2

Analyst x1

Is @ -8.41%

East @ -5.42%

Is @ -3.32%

Is @ -1.86%

Is @ -0.83%

Is @ -0.11%

Is at 0.39%

Present value (CA$, millions) discounted at 6.7%

CA$44.6

CA$46.4

CA$37.9

CA$32.5

CA$28.8

CA$26.1

CA$24.0

CA$22.3

CA$20.9

CA$19.6

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = 303 million Canadian dollars

We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.6%. We discount the terminal cash flows to their present value at a cost of equity of 6.7%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = C$38 million × (1 + 1.6%) ÷ (6.7%–1.6%) = C$742 million

Present value of terminal value (PVTV)= TV / (1 + r)ten= C$742m÷ (1 + 6.7%)ten= 388 million Canadian dollars

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is C$691 million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of C$14.4, the company looks quite undervalued at a 44% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.

dcf

Important assumptions

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Yellow Pages 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 takes debt into account. In this calculation, we used 6.7%, which is based on a leveraged beta of 1.214. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Can we understand why the company is trading at a discount to its intrinsic value? For the Yellow Pages, we have compiled three relevant factors that you should consider in more detail:

  1. Risks: For example, we discovered 2 yellow pages warning signs which you should be aware of before investing here.

  2. Future earnings: How does Y’s growth rate compare to that of its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.

  3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

PS. Simply Wall St updates its DCF calculation for every Canadian stock daily, so if you want to find the intrinsic value of any other stock, do a search here.

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

Calvin W. Soper