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Highlights
- DCF analysis indicates Deterra Royalties Limited may be fairly priced.
- Two-stage growth model used to forecast future cash flows.
- Final valuation shows a slight discount from the current share price.
Deterra Royalties Limited (ASX:DRR) has been evaluated using a Discounted Cash Flow (DCF) model to estimate its intrinsic value. This method focuses on projecting future cash flows and discounting them back to their present value, aiming to assess whether the current stock price aligns with the company's actual worth. The DCF model, though technical, provides a structured approach to valuing a business by incorporating future growth expectations and cash flow projections.
The DCF Model Explained
For this assessment, a two-stage DCF model is applied, which considers two phases of growth. In the first phase, a higher growth period is anticipated, gradually leading to a more stable growth rate in the second, or "steady growth," phase. This approach aligns with typical business cycles, where rapid growth often stabilizes over time.
To begin, an estimation of cash flows for the next ten years is conducted. In cases where analysts have not provided exact figures, previous free cash flow values are used as a base, and projections are made. For companies experiencing declining free cash flow, a slowing rate of shrinkage is anticipated, while those with positive growth see a moderated growth rate over the decade. This approach helps ensure that projected growth is realistic, especially during the initial years, which can be more volatile.
Calculating Total Equity Value
The projected cash flows over the ten years are combined with a terminal value, representing long-term steady cash flow projections. This total value is then divided by the number of outstanding shares to derive the company's intrinsic value. For Deterra Royalties Limited, this calculation yields an equity value of approximately AU$2.0 billion, positioning the current share price around 3.8% below this estimated value. With a current share price of AU$3.6, the analysis suggests the stock may be close to fair value based on these projections.
Key Assumptions to Consider
The DCF analysis depends heavily on certain assumptions, particularly the discount rate and projected cash flows. For Deterra Royalties, a discount rate of 7.1% was used, derived from a levered beta of 1.093, reflecting the company's volatility compared to the market. It's important to remember that DCF models do not consider cyclical industry trends or future capital requirements, which may impact a company’s long-term performance. In this case, the cost of equity was chosen as the discount rate, rather than the Weighted Average Cost of Capital (WACC), to focus on equity valuation.
While the DCF model offers insight into Deterra Royalties Limited’s intrinsic value, it's one of many valuation techniques, each with its limitations and assumptions.
