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Calculating The Fair Value Of Aerovate Therapeutics, Inc. (NASDAQ:AVTE)

In this article we are going to estimate the intrinsic value of Aerovate Therapeutics, Inc. (NASDAQ:AVTE) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Aerovate Therapeutics

The Method

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

-US$58.0m

-US$64.0m

-US$71.0m

-US$50.0m

US$24.0m

US$33.3m

US$42.6m

US$51.1m

US$58.5m

US$64.9m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Analyst x1

Analyst x1

Analyst x1

Est @ 38.80%

Est @ 27.75%

Est @ 20.02%

Est @ 14.61%

Est @ 10.82%

Present Value ($, Millions) Discounted @ 6.6%

-US$54.4

-US$56.4

-US$58.7

-US$38.8

US$17.5

US$22.7

US$27.3

US$30.7

US$33.0

US$34.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = -US$43m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$65m× (1 + 2.0%) ÷ (6.6%– 2.0%) = US$1.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.4b÷ ( 1 + 6.6%)10= US$763m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$720m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$29.3, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

The Assumptions

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 inputs, I recommend redoing the calculations yourself and playing with them. 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 Aerovate Therapeutics 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 6.6%, which is based on a levered beta of 0.824. 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 Aerovate Therapeutics

Strength

  • Currently debt free.

Weakness

  • Current share price is above our estimate of fair value.

Opportunity

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

Threat

  • Not expected to become profitable over the next 3 years.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Aerovate Therapeutics, we've compiled three relevant elements you should consider:

  1. Risks: Be aware that Aerovate Therapeutics is showing 3 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

  2. Future Earnings: How does AVTE'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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