Yahoo Finance Is Dechra Pharmaceuticals plc (LON:DPH) Expensive For A Reason? A Look At The Intrinsic Value
Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Dechra Pharmaceuticals plc (LON:DPH) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to today’s value. I will be using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not September 2018 then I highly recommend you check out the latest calculation for Dechra Pharmaceuticals by following the link below.
View our latest analysis for Dechra Pharmaceuticals
Crunching the numbers
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 five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF (£, Millions) | £91.15 | £105.33 | £119.40 | £134.00 | £155.44 |
Source | Analyst x4 | Analyst x4 | Analyst x2 | Analyst x1 | Est @ 16%, capped from 17.9% |
Present Value Discounted @ 8.28% | £84.18 | £89.83 | £94.05 | £97.48 | £104.43 |
Present Value of 5-year Cash Flow (PVCF)= UK£470.0m
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (1.4%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = UK£155.4m × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£2.29b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£2.29b ÷ ( 1 + 8.3%)5 = UK£1.54b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is UK£2.01b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of £19.64. Compared to the current share price of £24.52, the stock is fair value, maybe slightly overvalued at the time of writing.
Important assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Dechra Pharmaceuticals as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.3%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For DPH, I’ve put together three important factors you should further research:
Financial Health: Does DPH have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does DPH’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of DPH? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the LON every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
