In this article, we will estimate the intrinsic value of Virbac SA (EPA: VIRP) by projecting its future cash flows and then discounting them to the current value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in knowing a little more about intrinsic value should read the Simply Wall St analysis model.
See our latest analysis for Virbac
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (€, Millions)||€ 81.0m||106.1 M €||€ 116.9m||€ 127.4m||134.6 M €||140.1 M €||€ 144.3m||147.4 M €||149.8 M €||€ 151.7m|
|Source of growth rate estimate||Analyst x5||Analyst x5||Analyst x2||Analyst x2||East @ 5.67%||East @ 4.08%||Est @ 2.96%||Is @ 2.18%||East @ 1.64%||Is @ 1.25%|
|Present value (€, Millions) discounted at 4.5%||€ 77.5||€ 97.2||€ 102||107 €||€ 108||107 €||€ 106||104 €||€ 101||€ 97.5|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 1.0 billion euros
The second stage is also known as terminal value, this is the cash flow of the business after the first stage. 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 government bond yield of 0.4%. We discount the terminal cash flows to their present value at a cost of equity of 4.5%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = € 152m × (1 + 0.4%) ÷ (4.5% – 0.4%) = € 3.7bn
Present value of terminal value (PVTV)= TV / (1 + r)ten= € 3.7bn ÷ (1 + 4.5%)ten= € 2.4 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 3.4 billion euros. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of € 311, the company appears to be slightly undervalued with a discount of 22% compared to the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we consider Virbac as a potential shareholder, 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 have used 4.5%, which is based on a leverage beta of 0.800. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. It is not possible to achieve a rock-solid valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. What is the reason why the stock price is lower than intrinsic value? For Virbac, we have compiled three fundamental elements to assess:
- Risks: Every company has them, and we have spotted 3 warning signs for Virbac (of which 1 is of concern!) that you should know about.
- Future benefits: How does VIRP’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you might not have considered!
PS. Simply Wall St updates its DCF calculation for every French stock every day, so if you want to find the intrinsic value of another stock just search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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