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Magna International’s estimated fair value is CA$87.13 based on 2 Stage Free Cash Flow to Equity
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Current share price of CA$50.22 suggests Magna International is potentially 42% undervalued
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Our fair value estimate is 53% higher than Magna International’s analyst price target of US$56.96
How far off is Magna International Inc. (TSE:MG) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
|
2025 |
2026 |
2027 |
2028 |
2029 |
2030 |
2031 |
2032 |
2033 |
2034 |
|
|
Levered FCF ($, Millions) |
US$1.04b |
US$1.35b |
US$1.58b |
US$1.35b |
US$1.22b |
US$1.15b |
US$1.11b |
US$1.10b |
US$1.09b |
US$1.10b |
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Growth Rate Estimate Source |
Analyst x7 |
Analyst x7 |
Analyst x2 |
Analyst x1 |
Est @ -9.39% |
Est @ -5.83% |
Est @ -3.33% |
Est @ -1.59% |
Est @ -0.36% |
Est @ 0.49% |
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Present Value ($, Millions) Discounted @ 8.0% |
US$960 |
US$1.2k |
US$1.3k |
US$993 |
US$834 |
US$727 |
US$651 |
US$594 |
US$548 |
US$510 |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.2b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.5%) 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 8.0%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$1.1b× (1 + 2.5%) ÷ (8.0%– 2.5%) = US$21b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$21b÷ ( 1 + 8.0%)10= US$9.5b
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$18b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$50.2, the company appears quite undervalued at a 42% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula – garbage in, garbage out.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Magna International 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 1.264. 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.
View our latest analysis for Magna International
Strength
Weakness
Opportunity
Threat
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. What is the reason for the share price sitting below the intrinsic value? For Magna International, there are three important elements you should consider:
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Financial Health: Does MG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
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Future Earnings: How does MG’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.
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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. 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.