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Paladin Energy Ltd's (ASX:PDN) Intrinsic Value Is Potentially 28% Above Its Share Price

Key Insights

  • The projected fair value for Paladin Energy is AU$0.95 based on 2 Stage Free Cash Flow to Equity

  • Current share price of AU$0.74 suggests Paladin Energy is potentially 22% undervalued

  • The US$1.00 analyst price target for PDN is 5.7% 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 Paladin Energy Ltd (ASX:PDN) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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.

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Check out our latest analysis for Paladin Energy

Is Paladin Energy Fairly Valued?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

-US$74.5m

-US$48.0m

US$71.9m

US$98.9m

US$125.5m

US$149.8m

US$171.1m

US$189.0m

US$204.0m

US$216.5m

Growth Rate Estimate Source

Analyst x2

Analyst x2

Analyst x2

Est @ 37.61%

Est @ 26.90%

Est @ 19.41%

Est @ 14.17%

Est @ 10.50%

Est @ 7.93%

Est @ 6.13%

Present Value ($, Millions) Discounted @ 8.9%

-US$68.4

-US$40.5

US$55.6

US$70.3

US$81.9

US$89.8

US$94.1

US$95.5

US$94.7

US$92.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$565m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 8.9%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$216m× (1 + 1.9%) ÷ (8.9%– 1.9%) = US$3.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.2b÷ ( 1 + 8.9%)10= US$1.3b

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$1.9b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$0.7, the company appears a touch undervalued at a 22% 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.

dcf
dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Paladin Energy 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 8.9%, which is based on a levered beta of 1.174. 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 Paladin Energy

Strength

  • Debt is well covered by earnings.

Weakness

  • Shareholders have been diluted in the past year.

Opportunity

  • Forecast to reduce losses next year.

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

  • Trading below our estimate of fair value by more than 20%.

Threat

  • Debt is not well covered by operating cash flow.

Moving On:

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 Paladin Energy, we've put together three further elements you should further research:

  1. Risks: Take risks, for example - Paladin Energy has 2 warning signs we think you should be aware of.

  2. Future Earnings: How does PDN'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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