Key Insights

The projected fair value for Gold Road Resources is AU$1.39 based on 2 Stage Free Cash Flow to Equity Gold Road Resources' AU$1.75 share price signals that it might be 25% overvalued Analyst price target for GOR is AU$1.95, which is 40% above our fair value estimate

How far off is Gold Road Resources Limited (ASX:GOR) 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 forecast future cash flows of the company and discounting them back 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Gold Road Resources

The Model

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (A$, Millions)  AU$139.2m AU$158.2m AU$161.7m AU$135.3m AU$117.5m AU$109.7m AU$105.2m AU$102.8m AU$101.8m AU$101.7m Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x4 Analyst x1 Analyst x1 Est @ -6.67% Est @ -4.08% Est @ -2.27% Est @ -1.00% Est @ -0.11% Present Value (A$, Millions) Discounted @ 8.7%  AU$128 AU$134 AU$126 AU$97.0 AU$77.5 AU$66.5 AU$58.7 AU$52.8 AU$48.1 AU$44.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$833m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 8.7%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = AU$102m× (1 + 2.0%) ÷ (8.7%– 2.0%) = AU$1.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$1.5b÷ ( 1 + 8.7%)10= AU$670m

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$1.5b. 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$1.7, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind. 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. 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 Gold Road 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 8.7%, which is based on a levered beta of 1.132. 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 Gold Road Resources

Strength

Earnings growth over the past year exceeded the industry.

Currently debt free.

Weakness

Dividend is low compared to the top 25% of dividend payers in the Metals and Mining market.

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

Shareholders have been diluted in the past year.

Opportunity

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

Threat

Annual revenue is forecast to grow slower than the Australian market.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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. Why is the intrinsic value lower than the current share price? For Gold Road Resources, we've put together three pertinent items you should consider:

Risks: For example, we've discovered 1 warning sign for Gold Road Resources that you should be aware of before investing here. Future Earnings: How does GOR'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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