Denali Therapeutics Inc.'s (NASDAQ:DNLI) Intrinsic Value Is Potentially 69% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Denali Therapeutics fair value estimate is US$43.51
• Current share price of US$25.80 suggests Denali Therapeutics is potentially 41% undervalued
• The US$59.67 analyst price target for DNLI is 37% more than our estimate of fair value

Does the May share price for Denali Therapeutics Inc. (NASDAQ:DNLI) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present 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!

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.

View our latest analysis for Denali Therapeutics

Step By Step Through The Calculation

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.

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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	-US$415.3m	-US$447.7m	-US$353.1m	-US$224.2m	US$165.6m	US$243.3m	US$324.8m	US$402.9m	US$473.3m	US$534.1m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Analyst x2	Analyst x2	Est @ 46.95%	Est @ 33.49%	Est @ 24.06%	Est @ 17.47%	Est @ 12.85%
Present Value ($, Millions) Discounted @ 6.8%	-US$389	-US$392	-US$290	-US$172	US$119	US$164	US$205	US$238	US$261	US$276

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$20m

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$534m× (1 + 2.1%) ÷ (6.8%– 2.1%) = US$11b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$11b÷ ( 1 + 6.8%)¹⁰= US$5.9b

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$5.9b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$25.8, the company appears quite good value at a 41% discount to where the stock price trades currently. 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

We would point out that 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 Denali Therapeutics 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 6.8%, 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 Denali Therapeutics

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. 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 Denali Therapeutics, we've put together three fundamental elements you should consider:

1. Risks: Take risks, for example - Denali Therapeutics has 3 warning signs we think you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for DNLI'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 NASDAQGS 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.