How far off is Flexion Therapeutics Inc (NASDAQ:FLXN) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for Flexion Therapeutics by following the link below.
Is FLXN fairly valued?
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. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow estimate
|Levered FCF ($, Millions)||$-94.40||$-6.40||$105.04||$192.42||$223.21|
|Source||Analyst x2||Analyst x2||Analyst x1||Analyst x1||Est @ 16%, capped from 392.28%|
|Present Value Discounted @ 13.37%||$-83.27||$-4.98||$72.09||$116.50||$119.21|
Present Value of 5-year Cash Flow (PVCF)= US$220m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 13.4%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$223m × (1 + 2.9%) ÷ (13.4% – 2.9%) = US$2.2b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$2.2b ÷ ( 1 + 13.4%)5 = US$1.2b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$1.4b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $36.97. Relative to the current share price of $18.57, the stock is quite good value at a 50% discount to what it is available for right now.
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Flexion Therapeutics as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 13.4%, which is based on a levered beta of 1.477. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For FLXN, there are three key aspects you should look at:
- Financial Health: Does FLXN 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.
- Future Earnings: How does FLXN’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of FLXN? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.