A look at the fair value of Catalent, Inc. (NYSE: CTLT)
How far is Catalent, Inc. (NYSE: CTLT) from its intrinsic value? Using the most recent financial data, we’ll examine whether the share price is fair by estimating the company’s future cash flows and discounting them to their present value. One way to do this is to use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should have a read of the Simply Wall St.
Check out our latest review for Catalent
Crunch the numbers
We use what is called a 2-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. First, we need to estimate the cash flow of the business over the next ten years. 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 the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, 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 the later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year free cash flow (FCF) estimate
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, million) | – $ 533.3K | $ 227.6 million | $ 343.9 million | $ 436.2 million | $ 520.7 million | $ 594.5 million | $ 656.9 million | $ 709.2 million | $ 752.9 million | $ 789.9 million |
Source of estimated growth rate | Analyst x3 | Analyst x3 | Analyst x2 | Is 26.83% | Is at 19.38% | Is at 14.16% | Is at 10.51% | Is 7.95% | Is 6.17% | Is 4.91% |
Present value ($, millions) discounted at 5.8% | -0.5 USD | US $ 203 | US $ 290 | US $ 348 | US $ 393 | $ 424 | $ 443 | US $ 452 | US $ 454 | US $ 450 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 3.5 billion USD
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. 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 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 5.8%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = $ 790 million × (1 + 2.0%) ÷ (5.8% – 2.0%) = $ 21 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $ 21 billion ÷ (1 + 5.8%)^{ten}= 12 billion USD
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 16 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of US $ 102, the company is around fair value at the time of writing. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
Important assumptions
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. Part of investing is making 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 complete picture of a company’s potential performance. Since we view Catalent 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 into account debt. In this calculation, we used 5.8%, which is based on a leveraged beta of 0.806. Beta is a measure of the volatility of a stock, relative 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.
To move on:
While important, the DCF calculation ideally won’t be the only analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see how they would impact the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Catalent, there are three other things to consider:
- Risks: Concrete example, we have spotted 3 warning signs for Catalent you have to be aware of that, and one of them is a bit disturbing.
- Future income: How does CTLT’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions, 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 any stock, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in any of the stocks mentioned.
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