Key Insights

The projected fair value for Aeris Resources is AU$0.31 based on 2 Stage Free Cash Flow to Equity Aeris Resources is estimated to be 29% overvalued based on current share price of AU$0.40 The AU$0.85 analyst price target for AIS is 173% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Aeris Resources Limited (ASX:AIS) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Aeris Resources

The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

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

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (A$, Millions)  AU$49.7m AU$30.4m AU$21.1m AU$16.7m AU$14.4m AU$13.0m AU$12.3m AU$11.8m AU$11.6m AU$11.5m Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ -30.56% Est @ -20.81% Est @ -13.98% Est @ -9.20% Est @ -5.85% Est @ -3.51% Est @ -1.87% Est @ -0.72% Present Value (A$, Millions) Discounted @ 8.8%  AU$45.7 AU$25.6 AU$16.4 AU$11.9 AU$9.4 AU$7.9 AU$6.8 AU$6.0 AU$5.4 AU$5.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$140m

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 8.8%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$12m× (1 + 2.0%) ÷ (8.8%– 2.0%) = AU$172m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$172m÷ ( 1 + 8.8%)10= AU$74m

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$214m. 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$0.4, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out. dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Aeris 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 8.8%, which is based on a levered beta of 1.150. 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 Aeris Resources

Strength

Debt is not viewed as a risk.

Weakness

Expensive based on P/S ratio and estimated fair value.

Opportunity

Expected to breakeven next year.

Threat

No apparent threats visible for AIS.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Aeris Resources, there are three fundamental elements you should assess:

Financial Health: Does AIS 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. Future Earnings: How does AIS'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. 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. 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.

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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