Orexo AB (publ)'s (STO:ORX) Intrinsic Value Is Potentially 24% Below Its Share Price

Key Insights

• Orexo's estimated fair value is kr6.92 based on 2 Stage Free Cash Flow to Equity
• Orexo's kr9.14 share price signals that it might be 32% overvalued
• The kr31.00 analyst price target for ORX is 348% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Orexo AB (publ) (STO:ORX) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Orexo

Step By Step Through The Calculation

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 begin with, we have to get estimates of 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (SEK, Millions)	-kr27.0m	kr69.0m	kr39.0m	kr25.1m	kr18.9m	kr15.6m	kr13.8m	kr12.7m	kr12.0m	kr11.5m
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x1	Est @ -35.63%	Est @ -24.77%	Est @ -17.17%	Est @ -11.85%	Est @ -8.12%	Est @ -5.51%	Est @ -3.69%
Present Value (SEK, Millions) Discounted @ 6.7%	-kr25.3	kr60.6	kr32.1	kr19.3	kr13.6	kr10.6	kr8.7	kr7.5	kr6.7	kr6.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr140m

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 5-year average of the 10-year government bond yield of 0.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = kr12m× (1 + 0.6%) ÷ (6.7%– 0.6%) = kr188m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= kr188m÷ ( 1 + 6.7%)¹⁰= kr98m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is kr238m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of kr9.1, the company appears reasonably expensive at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Orexo 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 6.7%, which is based on a levered beta of 1.039. 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 Orexo

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Orexo, we've compiled three pertinent items you should look at:

1. Risks: For example, we've discovered 1 warning sign for Orexo that you should be aware of before investing here.
2. Future Earnings: How does ORX'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. Simply Wall St updates its DCF calculation for every Swedish 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.