Amgen Inc. (NASDAQ:AMGN) Shares Could Be 42% Below Their Intrinsic Value Estimate

Key Insights

• Amgen's estimated fair value is US$537 based on 2 Stage Free Cash Flow to Equity

• Amgen's US$309 share price signals that it might be 42% undervalued

• Our fair value estimate is 70% higher than Amgen's analyst price target of US$316

Does the July share price for Amgen Inc. (NASDAQ:AMGN) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Amgen

The Method

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of 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 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 ($, Millions)	US$12.9b	US$13.1b	US$13.8b	US$14.1b	US$14.4b	US$14.7b	US$15.0b	US$15.4b	US$15.8b	US$16.1b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x2	Analyst x2	Est @ 2.20%	Est @ 2.25%	Est @ 2.29%	Est @ 2.32%	Est @ 2.34%	Est @ 2.35%
Present Value ($, Millions) Discounted @ 6.9%	US$12.0k	US$11.5k	US$11.3k	US$10.8k	US$10.3k	US$9.9k	US$9.4k	US$9.0k	US$8.6k	US$8.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$101b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 6.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$16b× (1 + 2.4%) ÷ (6.9%– 2.4%) = US$365b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$365b÷ ( 1 + 6.9%)¹⁰= US$187b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$288b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$309, the company appears quite good value at a 42% 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.

dcf

Important 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 Amgen 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 6.9%, which is based on a levered beta of 0.984. 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 Amgen

Strength

• No major strengths identified for AMGN.

Weakness

• Earnings declined over the past year.

• Interest payments on debt are not well covered.

• Dividend is low compared to the top 25% of dividend payers in the Biotechs market.

Opportunity

• Annual earnings are forecast to grow faster than the American market.

• Trading below our estimate of fair value by more than 20%.

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by earnings.

• Annual revenue is forecast to grow slower than the American market.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For Amgen, there are three pertinent items you should assess:

1. Risks: Every company has them, and we've spotted 3 warning signs for Amgen (of which 1 shouldn't be ignored!) you should know about.

2. Future Earnings: How does AMGN'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.

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

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com