Is Laboratorios Farmaceuticos Rovi, S.A. (BME:ROVI) Trading At A 41% Discount?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Laboratorios Farmaceuticos Rovi fair value estimate is €146
• Laboratorios Farmaceuticos Rovi is estimated to be 41% undervalued based on current share price of €86.30
• Analyst price target for ROVI is €96.06 which is 34% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Laboratorios Farmaceuticos Rovi, S.A. (BME:ROVI) as an investment opportunity 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. There's really not all that much to it, even though it might appear quite complex.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Laboratorios Farmaceuticos Rovi

Is Laboratorios Farmaceuticos Rovi Fairly Valued?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (€, Millions)	€170.6m	€226.3m	€276.6m	€344.5m	€394.5m	€436.4m	€470.9m	€499.1m	€522.3m	€541.7m
Growth Rate Estimate Source	Analyst x5	Analyst x5	Analyst x3	Analyst x2	Est @ 14.51%	Est @ 10.62%	Est @ 7.90%	Est @ 5.99%	Est @ 4.65%	Est @ 3.72%
Present Value (€, Millions) Discounted @ 7.1%	€159	€197	€225	€262	€280	€289	€291	€288	€282	€273

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €2.5b

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = €542m× (1 + 1.5%) ÷ (7.1%– 1.5%) = €9.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €9.9b÷ ( 1 + 7.1%)¹⁰= €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 €7.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of €86.3, the company appears quite good value at a 41% 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Laboratorios Farmaceuticos Rovi 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 7.1%, 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.

SWOT Analysis for Laboratorios Farmaceuticos Rovi

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Laboratorios Farmaceuticos Rovi, we've compiled three further elements you should further examine:

1. Financial Health: Does ROVI 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 ROVI'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: 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. Simply Wall St updates its DCF calculation for every Spanish stock every day, so if you want to find the intrinsic value of any other stock 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.

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