A Look At The Fair Value Of Clinuvel Pharmaceuticals Limited (ASX:CUV)

In this article we are going to estimate the intrinsic value of Clinuvel Pharmaceuticals Limited (ASX:CUV) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

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.

View our latest analysis for Clinuvel Pharmaceuticals

What's the estimated valuation?

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.

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) forecast

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (A$, Millions)	AU$25.6m	AU$36.9m	AU$57.2m	AU$72.3m	AU$86.2m	AU$98.2m	AU$108.3m	AU$116.8m	AU$123.8m	AU$129.8m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Est @ 26.46%	Est @ 19.1%	Est @ 13.95%	Est @ 10.34%	Est @ 7.81%	Est @ 6.05%	Est @ 4.81%
Present Value (A$, Millions) Discounted @ 6.5%	AU$24.0	AU$32.5	AU$47.3	AU$56.2	AU$62.8	AU$67.2	AU$69.6	AU$70.5	AU$70.2	AU$69.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$569m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 6.5%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = AU$130m× (1 + 1.9%) ÷ (6.5%– 1.9%) = AU$2.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$2.9b÷ ( 1 + 6.5%)¹⁰= AU$1.5b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$2.1b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$43.6, the company appears around fair value at the time of writing. 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.

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Clinuvel Pharmaceuticals 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 6.5%, which is based on a levered beta of 0.974. 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:

Although the valuation of a company is important, 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Clinuvel Pharmaceuticals, there are three relevant factors you should assess:

1. Risks: Case in point, we've spotted 3 warning signs for Clinuvel Pharmaceuticals you should be aware of, and 1 of them makes us a bit uncomfortable.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CUV's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. 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. 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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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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