Is There An Opportunity With FibroGen, Inc.'s (NASDAQ:FGEN) 42% Undervaluation?
Key Insights
FibroGen's estimated fair value is US$2.48 based on 2 Stage Free Cash Flow to Equity
Current share price of US$1.44 suggests FibroGen is potentially 42% undervalued
The US$9.25 analyst price target for FGEN is 273% more than our estimate of fair value
In this article we are going to estimate the intrinsic value of FibroGen, Inc. (NASDAQ:FGEN) by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for FibroGen
The Calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | -US$123.9m | -US$42.8m | -US$15.0m | US$9.50m | US$15.5m | US$22.5m | US$29.7m | US$36.6m | US$42.7m | US$48.1m |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 63.35% | Est @ 44.98% | Est @ 32.12% | Est @ 23.12% | Est @ 16.81% | Est @ 12.40% |
Present Value ($, Millions) Discounted @ 9.0% | -US$114 | -US$36.0 | -US$11.6 | US$6.7 | US$10.1 | US$13.4 | US$16.3 | US$18.4 | US$19.7 | US$20.3 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = -US$56m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 9.0%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$48m× (1 + 2.1%) ÷ (9.0%– 2.1%) = US$711m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$711m÷ ( 1 + 9.0%)10= US$300m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$244m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$1.4, the company appears quite good value at a 42% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
Important 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 FibroGen 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 9.0%, which is based on a levered beta of 1.161. 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 FibroGen
Strength
Debt is well covered by earnings.
Weakness
Shareholders have been diluted in the past year.
Opportunity
Forecast to reduce losses next year.
Trading below our estimate of fair value by more than 20%.
Threat
Debt is not well covered by operating cash flow.
Has less than 3 years of cash runway based on current free cash flow.
Total liabilities exceed total assets, which raises the risk of financial distress.
Not expected to become profitable over the next 3 years.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For FibroGen, we've compiled three relevant factors you should further research:
Risks: As an example, we've found 5 warning signs for FibroGen (2 are potentially serious!) that you need to consider before investing here.
Future Earnings: How does FGEN'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: Do you like a good all-rounder? 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 updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.
