ADC Therapeutics SA (NYSE:ADCT) shares could be 50% below their estimated intrinsic value

Key findings

• Using the 2-step free cash flow to equity, the estimated fair value of ADC Therapeutics is $6.30.

• ADC Therapeutics is estimated to be undervalued by 50% based on the current share price of $3.16.

• The analyst price target of $10.00 for ADCT is 59% above our fair value estimate

How far is ADC Therapeutics SA (NYSE:ADCT) from its intrinsic value? Using the most recent financial data, we will check if the stock is fairly valued by taking the expected future cash flows and discounting them to today’s value. One way to do this is by applying the Discounted Cash Flow (DCF) model. Models like this may seem incomprehensible to a layperson, but they are relatively easy to follow.

Companies can be valued in many ways, so we want to point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, you can read the basics of this calculation in detail in Simply Wall St’s analysis model.

Check out our latest analysis for ADC Therapeutics

Processing the numbers

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. First, we need to estimate 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 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.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today. Therefore, the sum of these future cash flows is discounted to today’s value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = -89 million US dollars

The story goes on

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value, which takes into account all future cash flows after the first period. For various reasons, a very conservative growth rate is used, which cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.4%) 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 9.4%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = 116 million US dollars × (1 + 2.4%) ÷ (9.4% – 2.4%) = 1.7 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 1.7 billion US dollars ÷ (1 + 9.4%)¹⁰= 695 million US dollars

The total value is calculated by adding the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is $606 million. The final step is to divide the equity value by the number of shares outstanding. Relative to the current share price of $3.2, the company appears significantly undervalued at a 50% discount to the current share price. 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 cent.

The assumptions

The above calculation heavily relies on two assumptions. The first is the discount rate and the other is the cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. 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 consider ADC 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 takes debt into account. In this calculation, we used 9.4% which is based on a leveraged beta of 1.518. 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.

SWOT Analysis for ADC Therapeutics

Strength

weakness

Opportunity

Danger

Go on:

Valuation is only one side of the coin in developing your investment thesis and should not be the only metric you consider when researching a company. The DCF model is not a perfect tool for stock valuation. Rather, you should apply different cases and assumptions and see how they affect the valuation of the company. For example, slightly adjusting the terminal value growth rate can dramatically change the overall result. Why is the intrinsic value higher than the current share price? For ADC Therapeutics, there are three basic aspects you should consider:

1. Risks: Note that ADC Therapeutics shows 5 warning signals in our investment analysis and 1 of them makes us a little uncomfortable…

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

3. Other high-quality alternatives: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!

PS The Simply Wall St app does 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.

Do you have feedback on this article? Are you concerned about the content? Get in touch directly from us. Alternatively, send an email to editorial-team (at) simplywallst.com.

This Simply Wall St article is of a general nature. We comment 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.

Do you have feedback on this article? Are you interested in the content? Contact us directly. Alternatively, send an email to [email protected]