# Calculating The Intrinsic Value Of Lonza Group Ltd (VTX:LONN)

Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Lonza Group Ltd (VTX:LONN) as an investment opportunity by estimating the company’s future cash flows and discounting them to their present value. I will be using the Discounted Cash Flow (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Lonza Group

### Crunching the numbers

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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, 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

 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 Levered FCF (CHF, Millions) CHF685.6m CHF814.1m CHF1.10b CHF1.35b CHF1.54b CHF1.71b CHF1.86b CHF1.99b CHF2.11b CHF2.22b Growth Rate Estimate Source Analyst x10 Analyst x7 Analyst x3 Analyst x2 Est @ 14.3% Est @ 10.99% Est @ 8.68% Est @ 7.06% Est @ 5.92% Est @ 5.13% Present Value (CHF, Millions) Discounted @ 9.8% CHF624 CHF675 CHF828 CHF928 CHF965 CHF976 CHF965 CHF941 CHF907 CHF868

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CHF8.7b

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 10-year government bond rate of 3.3%. We discount the terminal cash flows to today’s value at a cost of equity of 9.8%.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = CHF2.2b× (1 + 3.3%) ÷ 9.8%– 3.3%) = CHF35b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CHF35b÷ ( 1 + 9.8%)10= CHF14b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CHF22b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CHF337, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula – garbage in, garbage out.

### The assumptions

We would point out that 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 Lonza Group 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 9.8%, which is based on a levered beta of 1.101. 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.

### Next Steps:

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. 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. For Lonza Group, There are three important factors you should look at:

1. Financial Health: Does LONN 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.
2. Future Earnings: How does LONN’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.
3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of LONN? 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 CH stock every day, so if you want to find the intrinsic value of any other stock just search here.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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