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PolyNovo Limited’s (ASX
NV) Intrinsic Value IsPotentially 95% Above Its Share Price
Simply Wall St - November 01, 2022
How far off is PolyNovo Limited (ASXNV) from itsintrinsic value? Using the most recent financial data, we'll take a look atwhether the stock is fairly priced by estimating the company's future cashflows and discounting them to their present value. One way to achieve this isby employing the Discounted Cash Flow (DCF) model. Don't get put off by thejargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company'svalue, and a DCF is just one method. If you still have some burning questionsabout this type of valuation, take a look at the Simply Wall St analysis model.
The Model
We are going to use a two-stage DCF model, which, as the namestates, takes into account two stages of growth. The first stage is generally ahigher growth period which levels off heading towards the terminal value,captured in the second 'steady growth' period. To start off with, we need toestimate the next ten years of cash flows. Where possible we use analystestimates, but when these aren't available we extrapolate the previous freecash flow (FCF) from the last estimate or reported value. We assume companieswith shrinking free cash flow will slow their rate of shrinkage, and thatcompanies with growing free cash flow will see their growth rate slow, overthis period. We do this to reflect that growth tends to slow more in the earlyyears than it does in later years.
A DCF is all about the idea that a dollar in the future is lessvaluable than a dollar today, so we discount the value of these future cashflows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
|
| 2023
| 2024
| 2025
| 2026
| 2027
| 2028
| 2029
| 2030
| 2031
| 2032
|
|---|
| 1 | Levered FCF (A$, Millions)
| AU$2.20m
| AU$14.2m
| AU$22.0m
| AU$45.0m
| AU$75.0m
| AU$99.6m
| AU$123.0m
| AU$143.9m
| AU$161.9m
| AU$176.9m
|
|---|
| 2 | Growth Rate Estimate Source
| Analyst x2
| Analyst x2
| Analyst x1
| Analyst x1
| Analyst x1
| Est @ 32.78%
| Est @ 23.51%
| Est @ 17.02%
| Est @ 12.47%
| Est @ 9.29%
|
|---|
| 3 | Present Value (A$, Millions) Discounted @ 6.5%
| AU$2.1
| AU$12.5
| AU$18.2
| AU$35.0
| AU$54.8
| AU$68.4
| AU$79.3
| AU$87.1
| AU$92.0
| AU$94.5
|
|---|
("Est"= FCF growth rate estimated by Simply Wall St)
PresentValue of 10-year Cash Flow (PVCF) = AU$543m
We nowneed to calculate the Terminal Value, which accounts for all the future cashflows after this ten year period. For a number of reasons a very conservativegrowth rate is used that cannot exceed that of a country's GDP growth. In thiscase we have used the 5-year average of the 10-year government bond yield(1.9%) to estimate future growth. In the same way as with the 10-year 'growth'period, we discount future cash flows to today's value, using a cost of equityof 6.5%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) =AU$177m× (1 + 1.9%) ÷ (6.5%– 1.9%) = AU$3.9b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10=AU$3.9b÷ ( 1 + 6.5%)10= AU$2.1b
Thetotal value, or equity value, is then the sum of the present value of thefuture cash flows, which in this case is AU$2.6b. In the final step we dividethe equity value by the number of shares outstanding. Relative to the currentshare price of AU$2.0, the company appears quite good value at a 49% discountto where the stock price trades currently. The assumptions in any calculationhave a big impact on the valuation, so it is better to view this as a roughestimate, not precise down to the last cent.
ASXNV Discounted Cash Flow November 1st2022
The Assumptions
Thecalculation above is very dependent on two assumptions. The first is thediscount rate and the other is the cash flows. Part of investing is coming upwith your own evaluation of a company's future performance, so try thecalculation yourself and check your own assumptions. The DCF also does notconsider the possible cyclicality of an industry, or a company's future capitalrequirements, so it does not give a full picture of a company's potentialperformance. Given that we are looking at PolyNovo as potential shareholders,the cost of equity is used as the discount rate, rather than the cost ofcapital (or weighted average cost of capital, WACC) which accounts for debt. Inthis calculation we've used 6.5%, which is based on a levered beta of 0.897.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 comparablecompanies, with an imposed limit between 0.8 and 2.0, which is a reasonablerange for a stable business.
Looking Ahead:
Althoughthe valuation of a company is important, it ideally won't be the sole piece ofanalysis you scrutinize for a company. DCF models are not the be-all andend-all of investment valuation. Instead the best use for a DCF model is totest certain assumptions and theories to see if they would lead to the companybeing undervalued or overvalued. For example, changes in the company's cost ofequity or the risk free rate can significantly impact the valuation. Can wework out why the company is trading at a discount to intrinsic value? ForPolyNovo, we've compiled three relevant elements you should consider:
1.Risks: Case in point, we'vespotted 1 warning sign for PolyNovoyou should be aware of.
2.Management:Have insiders been ramping uptheir shares to take advantage of the market's sentiment for PNV's futureoutlook? Check out our management and board analysis withinsights on CEO compensation and governance factors.
3.OtherHigh Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high qualitystocks to get an idea of what else is out there you may bemissing!
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