Estimating The Intrinsic Value Of Resource Development Group Limited (ASX:RDG)

Key Insights

• Resource Development Group's estimated fair value is AU$0.042 based on 2 Stage Free Cash Flow to Equity

• With AU$0.045 share price, Resource Development Group appears to be trading close to its estimated fair value

• Industry average of 4.8% suggests Resource Development Group's peers are currently trading at a lower premium to fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Resource Development Group Limited (ASX:RDG) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

View our latest analysis for Resource Development Group

The Calculation

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	-AU$6.00m	AU$3.00m	AU$4.40m	AU$5.86m	AU$7.26m	AU$8.51m	AU$9.59m	AU$10.5m	AU$11.3m	AU$11.9m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 46.59%	Est @ 33.21%	Est @ 23.85%	Est @ 17.30%	Est @ 12.71%	Est @ 9.50%	Est @ 7.25%	Est @ 5.68%
Present Value (A$, Millions) Discounted @ 8.5%	-AU$5.5	AU$2.6	AU$3.4	AU$4.2	AU$4.8	AU$5.2	AU$5.4	AU$5.5	AU$5.4	AU$5.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$36m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 8.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$12m× (1 + 2.0%) ÷ (8.5%– 2.0%) = AU$189m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$189m÷ ( 1 + 8.5%)¹⁰= AU$84m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$120m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$0.04, 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

Important Assumptions

We would point out that 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 Resource Development Group 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 8.5%, which is based on a levered beta of 1.288. 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 Resource Development Group

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is well covered by earnings.

Weakness

• No major weaknesses identified for RDG.

Opportunity

• Annual earnings are forecast to grow faster than the Australian market.

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

Threat

• Debt is not well covered by operating cash flow.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Resource Development Group, we've compiled three pertinent aspects you should assess:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Resource Development Group (at least 2 which are significant) , and understanding these should be part of your investment process.

2. Future Earnings: How does RDG'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX 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.