Is Mineral Resources Limited (ASX:MIN) trading at a 37% discount?
How far is Mineral Resources Limited (ASX:MIN) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by estimating the company’s future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. This may sound complicated, but it’s actually quite simple!
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St Analysis Template.
See our latest analysis for mineral resources
Are mineral resources valued at their fair value?
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF (A$, Millions) | -A$449.2 million | -A$509.5 million | A$419.9 million | A$540.8 million | A$652.7 million | A$750.8 million | A$833.9 million | A$903.0 million | A$960.2 million | A$1.01 billion |
Growth rate estimate Source | Analyst x3 | Analyst x2 | Analyst x3 | East @ 28.8% | Is at 20.7% | Is at 15.03% | Is at 11.06% | Is at 8.28% | Is at 6.34% | Is at 4.98% |
Present value (A$, millions) discounted at 6.6% | -AU$421 | -AU$448 | AU$346 | AU$418 | AU$473 | AU$510 | AU$532 | AU$540 | AU$538 | AU$530 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = AU$3.0 billion
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.8%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.6%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = AU$1.0 billion × (1 + 1.8%) ÷ (6.6%–1.8%) = AU$21 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= AU$21 billion÷ (1 + 6.6%)^{ten}= AU$11 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is A$14 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of AU$47.8, the company appears to have pretty good value at a 37% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
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 assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider mineral 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 takes debt into account. In this calculation, we used 6.6%, which is based on a leveraged beta of 1.142. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Next steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess 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 must be true for this stock to be under/overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is intrinsic value higher than the current stock price? For mineral resources, there are three relevant aspects you should consider:
- Risks: To this end, you should inquire about the 2 warning signs we spotted with Mineral Resources (including 1 which does not suit us too much).
- Future earnings: How does MIN’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Australian stock daily, so if you want to find the intrinsic value of any other stock, just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.