Calculating The Intrinsic Value Of Vulcan Energy Resources Limited (ASX:VUL)

Key Insights

• The projected fair value for Vulcan Energy Resources is AU$3.63 based on 2 Stage Free Cash Flow to Equity

• Current share price of AU$3.95 suggests Vulcan Energy Resources is potentially trading close to its fair value

• The €9.75 analyst price target for VUL is 169% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Vulcan Energy Resources Limited (ASX:VUL) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

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.

Check out our latest analysis for Vulcan Energy Resources

What's The Estimated Valuation?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (€, Millions)	-€1.03b	-€1.02b	€98.9m	€115.3m	€129.4m	€141.2m	€151.1m	€159.4m	€166.5m	€172.7m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Est @ 16.59%	Est @ 12.22%	Est @ 9.16%	Est @ 7.01%	Est @ 5.51%	Est @ 4.46%	Est @ 3.73%
Present Value (€, Millions) Discounted @ 7.6%	-€958	-€878	€79.3	€85.9	€89.6	€90.8	€90.3	€88.5	€85.9	€82.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = -€1.1b

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 (2.0%) 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 7.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = €173m× (1 + 2.0%) ÷ (7.6%– 2.0%) = €3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €3.1b÷ ( 1 + 7.6%)¹⁰= €1.5b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is €362m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$4.0, the company appears around fair value at the time of writing. 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

The 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 Vulcan Energy Resources 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 7.6%, which is based on a levered beta of 1.123. 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 Vulcan Energy Resources

Strength

• Currently debt free.

Weakness

• Shareholders have been diluted in the past year.

Opportunity

• Good value based on P/S ratio compared to estimated Fair P/S ratio.

• Significant insider buying over the past 3 months.

Threat

• Has less than 3 years of cash runway based on current free cash flow.

• Not expected to become profitable over the next 3 years.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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 Vulcan Energy Resources, there are three relevant factors you should further research:

1. Risks: As an example, we've found 3 warning signs for Vulcan Energy Resources (1 is potentially serious!) that you need to consider before investing here.

2. Future Earnings: How does VUL'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.

3. 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. Simply Wall St updates its DCF calculation for every Australian 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.