Diaceutics PLC (LON:DXRX) shares could be 24% above their estimated intrinsic value

Key findings

• The estimated fair value of Diaceutics is 0.97 GBP based on 2-step free cash flow to equity

• Diaceutics’ UK share price of £1.20 suggests the company could be overvalued by 24%

• Our fair value estimate is 44% below Diaceutics’ analyst price target of GBP 1.73.

Today we’re going to go through one way to estimate the intrinsic value of Diaceutics PLC (LON:DXRX) by projecting its future cash flows and then discounting those to today’s value. One way to do this is to apply the discounted cash flow (DCF) model. Before you think you can’t understand it, just read on! It’s actually a lot less complex than you think.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. For those who enjoy stock analysis, the analysis model presented here by Simply Wall St might be of interest.

Check out our latest analysis for Diaceutics

Is diaceutics evaluated fairly?

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. In the first stage, we need to estimate the company’s cash flows for 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 that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, we discount the value of these future cash flows to their estimated value in today’s dollars:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = £26 million

The story goes on

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 1.8%. We discount the terminal cash flows to today’s value at a cost of equity of 6.8%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = £5.4 million × (1 + 1.8%) ÷ (6.8% – 1.8%) = £108 million

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= £108 million ÷ (1 + 6.8%)¹⁰= £56 million

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is £82m. In the final step, we divide the equity value by the number of shares in issue. Compared to the current share price of £1.2, the company appears slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s better to consider this a rough estimate that isn’t accurate to the last penny.

Important assumptions

We would like to point out that the key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we view Diaceutics 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 takes debt into account. In this calculation, we used 6.8%, which is based on a leveraged beta of 0.922. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

Looking ahead:

While a company’s valuation is important, it is only one of many factors you need to evaluate a company. It is not possible to get a foolproof valuation using a DCF model. It should be viewed more as a guide to “what assumptions need to hold for this stock to be under/overvalued.” If a company grows at a different rate, or if its cost of equity or risk-free rate changes significantly, the outcome can be very different. What is causing the stock price to exceed intrinsic value? For Diaceutics, there are three basic elements you should examine:

1. Financial health: Does DXRX have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on important factors such as debt and risk.

2. management:Have insiders increased their shares to capitalize on market sentiment regarding DXRX’s future prospects? Read our management and board analysis with insights into CEO compensation and governance factors.

3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS Simply Wall St updates its DCF calculation for each UK stock daily, so if you want to find out the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We comment based solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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