Is Cochlear Limited (ASX:COH) Expensive For A Reason? A Look At Its Intrinsic Value

editorial-team@simplywallst.com (Simply Wall St)

Fri, Feb 7, 2025, 5:44 PM 6 min read

How far off is Cochlear Limited (ASX:COH) 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. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Cochlear

What's The Estimated Valuation?

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. In the first stage we need to estimate the cash flows to the business over 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 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (A$, Millions)	AU$398.3m	AU$410.6m	AU$493.0m	AU$564.0m	AU$635.0m	AU$688.4m	AU$734.2m	AU$774.1m	AU$809.6m	AU$841.8m
Growth Rate Estimate Source	Analyst x6	Analyst x6	Analyst x6	Analyst x2	Analyst x2	Est @ 8.41%	Est @ 6.66%	Est @ 5.43%	Est @ 4.58%	Est @ 3.98%
Present Value (A$, Millions) Discounted @ 6.5%	AU$374	AU$362	AU$408	AU$439	AU$464	AU$472	AU$473	AU$468	AU$460	AU$449

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$4.4b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = AU$842m× (1 + 2.6%) ÷ (6.5%– 2.6%) = AU$22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$22b÷ ( 1 + 6.5%)¹⁰= AU$12b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$16b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$310, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf — ASX:COH Discounted Cash Flow February 8th 2025

Important Assumptions

Now 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 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 Cochlear 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 6.5%, which is based on a levered beta of 0.948. 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 Cochlear

Strength

Currently debt free.

Weakness

Earnings growth over the past year underperformed the Medical Equipment industry.

Dividend is low compared to the top 25% of dividend payers in the Medical Equipment market.

Expensive based on P/E ratio and estimated fair value.

Opportunity

Annual revenue is forecast to grow faster than the Australian market.

Threat

Annual earnings are forecast to grow slower than the Australian market.

Next Steps:

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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price exceeding the intrinsic value? For Cochlear, there are three further aspects you should further examine:

Financial Health: Does COH 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 COH'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 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 ASX 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.