Key Insights

Canadian Tire Corporation's estimated fair value is CA$214 based on 2 Stage Free Cash Flow to Equity Canadian Tire Corporation's CA$149 share price signals that it might be 31% undervalued The CA$161 analyst price target for CTC.A is 25% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Canadian Tire Corporation, Limited (TSE:CTC.A) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

The Model

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF (CA$, Millions)  CA$381.0m CA$669.3m CA$786.0m CA$749.0m CA$902.0m CA$962.1m CA$1.01b CA$1.06b CA$1.10b CA$1.14b Growth Rate Estimate Source Analyst x3 Analyst x4 Analyst x1 Analyst x1 Analyst x1 Est @ 6.66% Est @ 5.37% Est @ 4.47% Est @ 3.84% Est @ 3.39% Present Value (CA$, Millions) Discounted @ 9.4%  CA$348 CA$559 CA$600 CA$523 CA$576 CA$561 CA$541 CA$516 CA$490 CA$463

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$5.2b

Story Continues

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 9.4%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CA$1.1b× (1 + 2.4%) ÷ (9.4%– 2.4%) = CA$17b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$17b÷ ( 1 + 9.4%)10= CA$6.7b

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 CA$12b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CA$149, the company appears quite good value at a 31% discount to where the stock price trades currently. 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.TSX:CTC.A Discounted Cash Flow March 27th 2025

The 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 Canadian Tire Corporation 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 9.4%, which is based on a levered beta of 1.625. 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.

Check out our latest analysis for Canadian Tire Corporation

SWOT Analysis for Canadian Tire Corporation

Strength

Earnings growth over the past year exceeded the industry.

Debt is well covered by earnings and cashflows.

Dividends are covered by earnings and cash flows.

Weakness

Dividend is low compared to the top 25% of dividend payers in the Multiline Retail market.

Opportunity

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

Threat

Annual earnings are forecast to decline for the next 3 years.

Looking Ahead:

Whilst important, the DCF calculation 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Canadian Tire Corporation, we've compiled three pertinent items you should further research:

Risks: We feel that you should assess the 3 warning signs for Canadian Tire Corporation (1 can't be ignored!) we've flagged before making an investment in the company. Future Earnings: How does CTC.A'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 Canadian 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.

View Comments