Does the 40% undervaluation of Barrick Gold Corporation (TSE:ABX) offer an opportunity?

Key findings

• Using the 2-step free cash flow to equity, the fair value of Barrick Gold is CA$37.55.
• Barrick Gold is estimated to be undervalued by 40% based on the current share price of CA$22.68
• The analyst price target of $29.68 for ABX is 21% below our fair value estimate

Does Barrick Gold Corporation (TSE:ABX)’s share price in June reflect its true value? Today we will estimate the stock’s intrinsic value by estimating the company’s future cash flows and discounting them to their present value. One way to do this is by applying the Discounted Cash Flow (DCF) model. There’s actually not too much to it, even though it may seem quite complex.

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 valuation metric among many, and it is not without its flaws. If you still have some burning questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Barrick Gold

Processing the numbers

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to get estimates for 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 that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the 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. Therefore, the sum of these future cash flows is discounted to today’s value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 17 billion US dollars

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.1%. We discount the terminal cash flows to today’s value at a cost of equity of 7.6%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = 3.5 billion US dollars × (1 + 2.1%) ÷ (7.6% – 2.1%) = 64 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 64 billion US dollars ÷ (1 + 7.6%)¹⁰= 31 billion US dollars

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is $48 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of CA$22.7, the company seems quite valuable at a 40% discount to the current share price. However, keep in mind that this is only an approximate valuation and as with any complex formula, where there’s garbage in, there’s garbage out.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. If you don’t agree with these results, try the calculation yourself and play with the assumptions. DCF also doesn’t take into account the potential cyclicality of an industry or a company’s future capital needs, and therefore doesn’t provide a complete picture of a company’s potential performance. Since we’re looking at Barrick Gold 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 7.6%, which is based on a leveraged beta of 1.205. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies, with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Barrick Gold

Looking ahead:

Although the DCF calculation is important, ideally it should not be the only analysis you look at for a company. The DCF model is not a perfect stock valuation tool. Rather, you should apply different cases and assumptions and see how they affect the company’s valuation. For example, slightly adjusting the terminal value growth rate can dramatically change the overall result. Can we find out why the company is trading at a discount to intrinsic value? For Barrick Gold, we have compiled three basic factors that you should examine in more detail:

1. Risks: Every company has them, and we have found 2 warning signals for Barrick Gold You should know about this.
2. management:Have insiders increased their shares to capitalize on market sentiment regarding ABX’s future prospects? Read our management and board analysis with insights into CEO compensation and governance factors.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS The Simply Wall St app runs a discounted cash flow valuation for every stock on the TSX every day. If you want to find the calculation for other stocks, just search here.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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