How far off is Oxford Biomedica plc (LON:OXB) 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 expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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.
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
Levered FCF (£, Millions)
-UK£29.7m
-UK£16.4m
UK£14.8m
UK£16.4m
UK£21.6m
UK£25.5m
UK£28.7m
UK£31.4m
UK£33.6m
UK£35.3m
Growth Rate Estimate Source
Analyst x4
Analyst x3
Analyst x2
Analyst x1
Analyst x1
Est @ 17.93%
Est @ 12.85%
Est @ 9.29%
Est @ 6.80%
Est @ 5.06%
Present Value (£, Millions) Discounted @ 6.9%
-UK£27.8
-UK£14.4
UK£12.1
UK£12.6
UK£15.5
UK£17.1
UK£18.0
UK£18.5
UK£18.4
UK£18.1
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = UK£88m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.0%) 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 6.9%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£605m÷ ( 1 + 6.9%)10= UK£311m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£399m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£4.4, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
LSE:OXB Discounted Cash Flow January 1st 2023
The Assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Oxford Biomedica 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 0.927. 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 Oxford Biomedica
Strength
Debt is well covered by earnings.
Weakness
Shareholders have been diluted in the past year.
Opportunity
Has sufficient cash runway for more than 3 years based on current free cash flows.
Good value based on P/S ratio compared to estimated Fair P/S ratio.
Significant insider buying over the past 3 months.
Threat
Debt is not well covered by operating cash flow.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. For Oxford Biomedica, we've put together three essential items you should further research:
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for OXB's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock just search here.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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