Are investors undervaluing Silk Road Medical, Inc (NASDAQ:SILK) by 33%?
In this article, we will estimate the intrinsic value of Silk Road Medical, Inc (NASDAQ:SILK) by projecting its future cash flows and then discounting them to present value. This will be done using the discounted cash flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF ($, millions)||-$33.9 million||-$16.8 million||$12.9 million||$22.9 million||$35.5 million||$49.4 million||$63.2 million||$76.0 million||$87.1 million||$96.6 million|
|Growth rate estimate Source||Analyst x2||Analyst x2||Analyst x1||Is at 77.86%||Is at 55.09%||Is at 39.15%||Is at 28%||East @ 20.18%||Is at 14.72%||Is at 10.89%|
|Present value (in millions of dollars) discounted at 5.9%||-US$32.0||-US$14.9||$10.8||$18.2||$26.6||$35.0||$42.2||$47.9||$51.9||$54.3|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $240 million
The second stage is also known as the terminal value, it 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 10-year government bond yield of 2.0%. We discount terminal cash flows to present value at a cost of equity of 5.9%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$97 million × (1 + 2.0%) ÷ (5.9%–2.0%) = US$2.5 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $2.5 billion ÷ (1 + 5.9%)ten= $1.4 billion
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $1.6 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 $31.2, the company appears to be pretty good value at a 33% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.
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 entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Silk Road Medical 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 5.9%, which is based on a leveraged beta of 0.906. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. DCF models are not the be-all and end-all of investment valuation. 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 the valuation. Why is the stock price below intrinsic value? For Silk Road Medical, we have compiled three important things for you to assess:
- Risks: Every business has them, and we’ve spotted 3 warning signs for Silk Road Medical you should know.
- Future earnings: How does SILK’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every US stock daily, so if you want to find the intrinsic value of any other stock, do a search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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