Calculating The Intrinsic Value Of Volpara Health Technologies Limited (ASX:VHT)

By
Simply Wall St
Published
June 03, 2021
ASX:VHT
Source: Shutterstock

In this article we are going to estimate the intrinsic value of Volpara Health Technologies Limited (ASX:VHT) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Volpara Health Technologies

The method

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. To start off with, we need to estimate 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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (NZ$, Millions) -NZ$13.5m -NZ$6.20m -NZ$1.20m NZ$3.50m NZ$5.81m NZ$8.54m NZ$11.4m NZ$14.1m NZ$16.6m NZ$18.7m
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Analyst x1 Est @ 66.23% Est @ 46.93% Est @ 33.43% Est @ 23.98% Est @ 17.36% Est @ 12.73%
Present Value (NZ$, Millions) Discounted @ 5.7% -NZ$12.8 -NZ$5.5 -NZ$1.0 NZ$2.8 NZ$4.4 NZ$6.1 NZ$7.7 NZ$9.1 NZ$10.1 NZ$10.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$31m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case 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 equity of 5.7%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = NZ$19m× (1 + 1.9%) ÷ (5.7%– 1.9%) = NZ$504m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$504m÷ ( 1 + 5.7%)10= NZ$290m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$321m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$1.3, 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.

dcf
ASX:VHT Discounted Cash Flow June 4th 2021

The 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 Volpara Health Technologies 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 5.7%, which is based on a levered beta of 0.800. 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.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Volpara Health Technologies, there are three relevant aspects you should assess:

  1. Financial Health: Does VHT 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 VHT'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 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks just search here.

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