Is There An Opportunity With Teva Pharmaceutical Industries Limited's (NYSE:TEVA) 42.22% Undervaluation? – Simply Wall St

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How far off is Teva Pharmaceutical Industries Limited (NYSE:TEVA) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today’s value. This is done using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not January 2018 then I highly recommend you check out the latest calculation for Teva Pharmaceutical Industries by following the link below. View our latest analysis for Teva Pharmaceutical Industries

The method

I’m 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 perpetual stable growth rate. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

2018 2019 2020 2021 2022
Levered FCF ($, Millions) $3,315.68 $3,365.33 $3,450.65 $4,054.30 $4,046.00
Source Analyst x4 Analyst x4 Analyst x2 Analyst x1 Analyst x1
Present Value Discounted @ 11.72% $2,967.76 $2,696.12 $2,474.40 $2,602.20 $2,324.38

Present Value of 5-year Cash Flow (PVCF)= $13,065

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.5%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 11.7%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = $4,046 × (1 + 2.5%) ÷ (11.7% – 2.5%) = $44,805

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = $44,805 / ( 1 + 11.7%)5 = $25,740

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is $38,805. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $38.19, which, compared to the current share price of $22.07, we find that Teva Pharmaceutical Industries is quite good value at a 42.22% discount to what it is available for right now.

NYSE:TEVA Intrinsic Value Jan 14th 18

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Teva Pharmaceutical Industries as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11.7%, which is based on a levered beta of 1.229. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For TEVA, there are three key aspects you should further examine:

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NYSE every 6 hours. If you want to find the calculation for other stocks just search here.

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