An Intrinsic Calculation For Ultragenyx Pharmaceutical Inc. (NASDAQ:RARE) Suggests It's 50% Undervalued

Key Insights

• The projected fair value for Ultragenyx Pharmaceutical is US$102 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$51.42 suggests Ultragenyx Pharmaceutical is potentially 50% undervalued
• The US$90.75 analyst price target for RARE is 11% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Ultragenyx Pharmaceutical Inc. (NASDAQ:RARE) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Ultragenyx Pharmaceutical

The Model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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 ($, Millions)	-US$480.9m	-US$379.8m	-US$300.2m	-US$117.3m	US$168.9m	US$259.6m	US$358.8m	US$457.0m	US$547.5m	US$626.8m
Growth Rate Estimate Source	Analyst x3	Analyst x4	Analyst x3	Analyst x3	Analyst x3	Est @ 53.68%	Est @ 38.21%	Est @ 27.38%	Est @ 19.80%	Est @ 14.49%
Present Value ($, Millions) Discounted @ 6.9%	-US$450	-US$333	-US$246	-US$89.9	US$121	US$174	US$225	US$269	US$301	US$323

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$295m

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 6.9%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$627m× (1 + 2.1%) ÷ (6.9%– 2.1%) = US$13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$13b÷ ( 1 + 6.9%)¹⁰= US$6.9b

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$7.2b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$51.4, the company appears quite undervalued at a 50% 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 Ultragenyx Pharmaceutical 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 6.9%, 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 Ultragenyx Pharmaceutical

Moving On:

Although the valuation of a company is important, 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. 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. Can we work out why the company is trading at a discount to intrinsic value? For Ultragenyx Pharmaceutical, there are three additional factors you should further research:

1. Risks: Case in point, we've spotted 2 warning signs for Ultragenyx Pharmaceutical you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for RARE'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.