Are Investors Undervaluing Brookfield Renewable Corporation (TSE:BEPC) by 27%?

Key insights

• Brookfield Renewable has a projected fair value of C$54.50 based on two-step free cash flow to equity

• The current share price of C$39.77 suggests that Brookfield Renewable is potentially undervalued by 27%.

• The analyst price target for BEPC is $42.29, which is 22% below our fair value estimate

How far is Brookfield Renewable Corporation (TSE:BEPC) from its intrinsic value? Using the latest financial data, we’ll check whether the stock is fairly valued by estimating the company’s future cash flows and discounting them to their present value. On this occasion, we will use the discounted cash flow (DCF) model. Believe it or not, this is not too difficult to follow, as you will see in our example!

We generally believe that a company’s value is the present value of all the cash it will generate in the future. However, DCF is only one of many valuation metrics and is not without its drawbacks. For those who are eager to learn stock analysis, the Simply Wall St analysis model presented here may be of interest.

View our latest analysis for Brookfield Renewable

Calculation

We will use a two-stage DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is generally a period of higher growth, which slows down towards the final value, captured in the second period of “sustainable growth”. First, we need to estimate cash flows 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 that 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 the fact that economic growth tends to slow more in the early years than in later years.

We generally 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:

Free cash flow (FCF) forecast for 10 years

(“Est” = FCF growth rate estimated by Simply Wall St)
10-year Present Value of Cash Flows (PVCF) = $6.8 billion

The story continues

After calculating the present value of the future cash flows over the initial 10-year period, you need to calculate the Final Value, which takes into account all future cash flows after the first stage. For many reasons, a very conservative growth rate is used, which cannot exceed the GDP growth rate of a given country. In this case, we used the 5-year average yield on 10-year government bonds (2.1%) to estimate future growth. As with the 10-year “growth” period, we discount future cash flows to today’s value using a cost of equity of 6.7%.

Final value (TV)=FCF₂₀₃₃ × (1 + g) ÷ (r – g) = $693 million × (1 + 2.1%) ÷ (6.7% – 2.1%) = $15 billion

Present Value Final Value (PVTV)= television / (1 + r)¹⁰= $15 billion ÷ ( 1 + 6.7%)¹⁰= USD 8.1 billion

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $15 billion. The final step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of C$39.8, the company appears slightly undervalued at a 27% discount to the current share price. However, valuations are imprecise instruments, they resemble a telescope – you just need to move a few degrees and find yourself in another galaxy. Remember that.

Assumptions

The above calculations are largely dependent on two assumptions. The first is the discount rate, the second is cash flows. You don’t have to agree with these inputs, I recommend repeating the calculations yourself and playing around with them. DCF also does not take into account the possible cyclicality of the industry or the company’s future capital requirements, so it does not provide a complete picture of the company’s potential performance. Given that we view Brookfield Renewable as a potential shareholder, the discount rate is the cost of equity capital, rather than the cost of capital (or weighted average cost of capital, WACC), which takes into account debt. We used 6.7% in these calculations based on a leveraged beta of 0.994. Beta is a measure of a stock’s volatility compared to the market as a whole. We obtain our beta from the industry average beta of comparable companies around the world, with an imposed limit of 0.8 to 2.0, which is a reasonable range for a stable business.

SWOT analysis for Brookfield Renewable

Resilience

Weakness

Possibility

Danger

Looking to the future:

While company valuation is important, ideally it will not be the only element of analysis you will analyze for the company. DCF models are not the ultimate investment valuation tool. It’s best to use different cases and assumptions and see how they affect the company’s valuation. If a company is growing at a different pace, or if its cost of equity capital or risk-free rate changes dramatically, the results may look very different. Can we determine why the company is trading at a discount to intrinsic value? In the case of Brookfield Renewable, we have gathered three important issues that are worth further examination:

1. Risk: As an example we found 4 warning signs for Brookfield Renewable (2 are a bit concerning!) that you should consider before investing here.

2. Future earnings: How does BEPC’s growth rate compare to peers and the broader market? Take a closer look at analyst consensus for the coming years with our free analyst growth expectations chart.

3. Other solid companies: Low debt, high rate of return on equity and good past performance are the basis of a strong business. We encourage you to check out our interactive stock list with solid business fundamentals to see if there are other stocks you may not have considered!

PS. Simply Wall St updates its DCF calculations for every Canadian stock daily, so if you want to know the intrinsic value of other stocks, just search here.

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This article by Simply Wall St is of a general nature. We comment based on historical data and analyst forecasts, using only an unbiased methodology, and our articles are not intended to provide 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 long-term, focused analysis based on fundamental data. Please note that our analysis may not reflect the latest price-sensitive company announcements or qualitative content. Simply Wall St has no position in any of the stocks mentioned.

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