Calculating The Intrinsic Value Of Eli Lilly and Company (NYSE:LLY)

Eli Lilly and Company +0.17%

Eli Lilly and Company

LLY

867.30

+0.17%

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Eli Lilly fair value estimate is US$591
  • With US$560 share price, Eli Lilly appears to be trading close to its estimated fair value
  • Analyst price target for LLY is US$594 which is similar to our fair value estimate

Today we will run through one way of estimating the intrinsic value of Eli Lilly and Company (NYSE:LLY) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Eli Lilly

The Model

We're 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 a stable growth rate. To start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$8.57b US$11.7b US$16.1b US$18.9b US$21.1b US$22.9b US$24.4b US$25.6b US$26.7b US$27.7b
Growth Rate Estimate Source Analyst x9 Analyst x9 Analyst x4 Analyst x4 Est @ 11.20% Est @ 8.48% Est @ 6.58% Est @ 5.25% Est @ 4.32% Est @ 3.67%
Present Value ($, Millions) Discounted @ 6.2% US$8.1k US$10.4k US$13.4k US$14.9k US$15.6k US$16.0k US$16.0k US$15.9k US$15.6k US$15.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$141b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.2%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$28b× (1 + 2.2%) ÷ (6.2%– 2.2%) = US$708b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$708b÷ ( 1 + 6.2%)10= US$390b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$531b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$560, the company appears about fair value at a 5.1% discount to where the stock price trades currently. 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.

dcf
NYSE:LLY Discounted Cash Flow October 30th 2023

Important Assumptions

Now 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 Eli Lilly 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 6.2%, which is based on a levered beta of 0.800. 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 Eli Lilly

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
Weakness
  • Earnings growth over the past year is below its 5-year average.
  • Dividend is low compared to the top 25% of dividend payers in the Pharmaceuticals market.
Opportunity
  • Annual earnings are forecast to grow faster than the American market.
  • Current share price is below our estimate of fair value.
Threat
  • Revenue is forecast to grow slower than 20% per year.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Eli Lilly, we've put together three additional aspects you should look at:

  1. Risks: Take risks, for example - Eli Lilly has 1 warning sign we think you should be aware of.
  2. Future Earnings: How does LLY's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!

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

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