Calculating The Intrinsic Value Of Diaceutics PLC (LON:DXRX)

Key Insights

• The projected fair value for Diaceutics is UK£0.89 based on 2 Stage Free Cash Flow to Equity

• With UK£1.05 share price, Diaceutics appears to be trading close to its estimated fair value

• Analyst price target for DXRX is UK£1.72, which is 93% above our fair value estimate

In this article we are going to estimate the intrinsic value of Diaceutics PLC (LON:DXRX) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Diaceutics

The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	-UK£3.04m	UK£1.38m	UK£2.06m	UK£2.79m	UK£3.48m	UK£4.11m	UK£4.64m	UK£5.08m	UK£5.44m	UK£5.73m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Est @ 49.67%	Est @ 35.18%	Est @ 25.04%	Est @ 17.94%	Est @ 12.97%	Est @ 9.50%	Est @ 7.06%	Est @ 5.36%
Present Value (£, Millions) Discounted @ 6.8%	-UK£2.9	UK£1.2	UK£1.7	UK£2.1	UK£2.5	UK£2.8	UK£2.9	UK£3.0	UK£3.0	UK£3.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£19m

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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£5.7m× (1 + 1.4%) ÷ (6.8%– 1.4%) = UK£107m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£107m÷ ( 1 + 6.8%)¹⁰= UK£56m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£75m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£1.1, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf

The Assumptions

Now 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 Diaceutics 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 6.8%, which is based on a levered beta of 0.916. 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 Diaceutics

Strength

• Currently debt free.

Weakness

• Earnings declined over the past year.

Opportunity

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

• Good value based on P/S ratio compared to estimated Fair P/S ratio.

Threat

• Revenue is forecast to grow slower than 20% per year.

Moving On:

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. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Diaceutics, we've put together three further elements you should further examine:

1. Risks: Every company has them, and we've spotted 1 warning sign for Diaceutics you should know about.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for DXRX's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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 AIM 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.