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. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. If you are reading this after May 2018 then I highly recommend you check out the latest calculation for Aralez Pharmaceuticals here.
What’s the value?
I’ve used the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. 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 figures at the cost of equity of 17.87%. This resulted in a present value of 5-year cash flow of US$24.35M. Want to understand how I calculated this value? Take a look at our detailed analysis here.
In the visual above, we see how how ARZ’s top and bottom lines are expected to move going forward, which should give you an idea of ARZ’s outlook. Secondly, 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 perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. After discounting the terminal value back five years, the present value becomes US$31.13M.
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 US$55.48M. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of CA$1.05, which, compared to the current share price of CA$0.64, we find that Aralez Pharmaceuticals is quite good value at a 39.31% discount to what it is available for right now.
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 ARZ, I’ve put together three relevant aspects you should further research:
- Financial Health: Does ARZ 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 ARZ’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 ARZ? 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 CA stock every 6 hours, so if you want to find the intrinsic value of any other stock 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.