Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of Aralez Pharmaceuticals Inc (TSX:ARZ) as an investment opportunity. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Also note that this article was written in November 2017 so be sure check the latest calculation for Aralez Pharmaceuticals here.
What’s the value?
I will be using the 2-stage growth model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. Generally I like to use analyst consensus estimates for free cash flow, but given that ARZ has low analyst coverage with no forecast available, I have extrapolated the most recent reported free cash flow (FCF) based on the average annual revenue growth over the past five years, capped at a reasonable level, and discounted these values at the cost of equity of 17.53%. This resulted in a present value of 5-year cash flow of CA$41M. Keen to know how I arrived at this number? Take a look at our detailed analysis here.
Above is a visual representation of how ARZ’s top and bottom lines are expected to move going forward, which should give you some color on ARZ’s outlook. Then, I determine the terminal value, which is the business’s cash flow after the first stage. I’ve decided to use the 10-year government bond rate of 2.8% as the steady growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is CA$55M.
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 CA$96M. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of CA$1.86, which, compared to the current share price of CA$1.86, we find that Aralez Pharmaceuticals is fair value, maybe slightly overvalued and not available at a discount at this time.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company.
For ARZ, there are three pertinent aspects you should further examine:
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the TSX every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see pass 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.