Is Establishment Labs Holdings Inc. (NASDAQ:ESTA) Trading At A 21% Discount?

Key Insights

• The projected fair value for Establishment Labs Holdings is US$54.78 based on 2 Stage Free Cash Flow to Equity
• Establishment Labs Holdings is estimated to be 21% undervalued based on current share price of US$43.08
• Analyst price target for ESTA is US$60.29, which is 10% above our fair value estimate

In this article we are going to estimate the intrinsic value of Establishment Labs Holdings Inc. (NASDAQ:ESTA) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Establishment Labs Holdings

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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)	-US$8.00m	US$27.0m	US$50.6m	US$82.1m	US$118.4m	US$155.9m	US$191.8m	US$224.2m	US$252.5m	US$276.8m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 87.54%	Est @ 62.06%	Est @ 44.23%	Est @ 31.75%	Est @ 23.01%	Est @ 16.89%	Est @ 12.61%	Est @ 9.61%
Present Value ($, Millions) Discounted @ 12%	-US$7.1	US$21.4	US$35.8	US$51.8	US$66.5	US$78.1	US$85.6	US$89.2	US$89.5	US$87.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$598m

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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$277m× (1 + 2.6%) ÷ (12%– 2.6%) = US$3.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$3.0b÷ ( 1 + 12%)¹⁰= US$935m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$1.5b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$43.1, the company appears a touch undervalued at a 21% 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Establishment Labs Holdings 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 12%, which is based on a levered beta of 0.997. 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 Establishment Labs Holdings

Next Steps:

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. 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. Can we work out why the company is trading at a discount to intrinsic value? For Establishment Labs Holdings, we've compiled three relevant elements you should further research:

1. Risks: For example, we've discovered 2 warning signs for Establishment Labs Holdings that you should be aware of before investing here.
2. Future Earnings: How does ESTA'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQCM 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.