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Is There An Opportunity With Mirati Therapeutics, Inc.'s (NASDAQ:MRTX) 36% Undervaluation?

Key Insights

  • The projected fair value for Mirati Therapeutics is US$69.74 based on 2 Stage Free Cash Flow to Equity

  • Mirati Therapeutics' US$44.94 share price signals that it might be 36% undervalued

  • The US$70.13 analyst price target for MRTXis comparable to our estimate of fair value.

Today we will run through one way of estimating the intrinsic value of Mirati Therapeutics, Inc. (NASDAQ:MRTX) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Mirati Therapeutics

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. To begin with, we have to get estimates of 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

-US$731.1m

-US$667.3m

-US$519.4m

-US$482.6m

US$164.7m

US$229.4m

US$293.9m

US$353.7m

US$406.2m

US$450.9m

Growth Rate Estimate Source

Analyst x5

Analyst x5

Analyst x4

Analyst x2

Analyst x4

Est @ 39.32%

Est @ 28.14%

Est @ 20.32%

Est @ 14.85%

Est @ 11.01%

Present Value ($, Millions) Discounted @ 6.8%

-US$684

-US$585

-US$426

-US$370

US$118

US$154

US$185

US$208

US$224

US$233

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = -US$942m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$451m× (1 + 2.1%) ÷ (6.8%– 2.1%) = US$9.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$9.7b÷ ( 1 + 6.8%)10= US$5.0b

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$4.0b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$44.9, the company appears quite undervalued at a 36% 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.

dcf
dcf

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Mirati Therapeutics 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 0.802. 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 Mirati Therapeutics

Strength

  • Currently debt free.

Weakness

  • Shareholders have been diluted in the past year.

Opportunity

  • Trading below our estimate of fair value by more than 20%.

Threat

  • Has less than 3 years of cash runway based on current free cash flow.

  • Not expected to become profitable over the next 3 years.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Mirati Therapeutics, we've put together three essential items you should assess:

  1. Risks: As an example, we've found 4 warning signs for Mirati Therapeutics that you need to consider before investing here.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for MRTX'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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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