Eli Lilly and Company's (NYSE:LLY) Intrinsic Value Is Potentially 81% Above Its Share Price

By
Simply Wall St
Published
January 27, 2022
NYSE:LLY
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How far off is Eli Lilly and Company (NYSE:LLY) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Eli Lilly

The model

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$7.62b US$7.82b US$9.53b US$11.1b US$12.8b US$14.1b US$15.1b US$16.0b US$16.8b US$17.4b
Growth Rate Estimate Source Analyst x10 Analyst x11 Analyst x7 Analyst x6 Analyst x6 Est @ 9.85% Est @ 7.48% Est @ 5.82% Est @ 4.67% Est @ 3.85%
Present Value ($, Millions) Discounted @ 5.5% US$7.2k US$7.0k US$8.1k US$9.0k US$9.8k US$10.2k US$10.4k US$10.5k US$10.4k US$10.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$93b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 5.5%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$17b× (1 + 2.0%) ÷ (5.5%– 2.0%) = US$507b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$507b÷ ( 1 + 5.5%)10= US$298b

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$391b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$238, the company appears quite good value at a 45% 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.

dcf
NYSE:LLY Discounted Cash Flow January 27th 2022

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 Eli Lilly 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 5.5%, 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.

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. 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Eli Lilly, we've compiled three pertinent factors you should look at:

  1. Risks: Be aware that Eli Lilly is showing 1 warning sign in our investment analysis , you should know about...
  2. Future Earnings: How does LLY'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

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