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Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Akebia Therapeutics, Inc. (NASDAQ:AKBA) as an investment opportunity by projecting its future cash flows and then discounting them to today’s value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in February 2019 so be sure check out the updated calculation by following the link below.
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF ($, Millions)||$-222.05||$-129.02||$119.69||$109.69||$211.68|
|Source||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Analyst x1|
|Present Value Discounted @ 13.1%||$-196.33||$-100.86||$82.73||$67.04||$114.38|
Present Value of 5-year Cash Flow (PVCF)= -US$33.0m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.7%. We discount this to today’s value at a cost of equity of 13.1%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$212m × (1 + 2.7%) ÷ (13.1% – 2.7%) = US$2.1b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$2.1b ÷ ( 1 + 13.1%)5 = US$1.1b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$1.1b. In the final step we 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) or ADR then we use the equivalent number. This results in an intrinsic value of $9.41. Relative to the current share price of $6.65, the stock is about right, perhaps slightly undervalued at a 29% discount to what it is available for right now.
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 Akebia Therapeutics 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 13.1%, which is based on a levered beta of 1.426. 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.
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 AKBA, there are three fundamental aspects you should further examine:
- Financial Health: Does AKBA 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 AKBA’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 AKBA? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. On rare occasion, data errors may occur. Thank you for reading.