Array BioPharma Inc (NASDAQ:ARRY) Is Trading At A 48.17% Discount
Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Array BioPharma Inc (NASDAQ:ARRY) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. This is done using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. 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 November 2018 then I highly recommend you check out the latest calculation for Array BioPharma by following the link below.
See our latest analysis for Array BioPharma
The method
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 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. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF ($, Millions) | $-63.50 | $-24.00 | $357.00 | $685.00 | $856.00 |
Source | Analyst x2 | Analyst x2 | Analyst x1 | Analyst x1 | Analyst x1 |
Present Value Discounted @ 12.69% | $-56.35 | $-18.90 | $249.46 | $424.74 | $470.99 |
Present Value of 5-year Cash Flow (PVCF)= US$1.1b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 12.7%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$856m × (1 + 2.9%) ÷ (12.7% – 2.9%) = US$9.0b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$9.0b ÷ ( 1 + 12.7%)5 = US$5.0b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$6.0b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $28.38. Compared to the current share price of $14.71, the stock is quite undervalued at a 48% discount to what it is available for right now.
The assumptions
I’d like to 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Array BioPharma 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 12.7%, which is based on a levered beta of 1.382. 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:
Although the valuation of a company is important, 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 ARRY, there are three important factors you should further examine:
Financial Health: Does ARRY 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 ARRY’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 ARRY? 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 NASDAQ 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.
