Key Insights

Centessa Pharmaceuticals' estimated fair value is US$23.94 based on 2 Stage Free Cash Flow to Equity Current share price of US$16.75 suggests Centessa Pharmaceuticals is potentially 30% undervalued Analyst price target for CNTA is US$28.57, which is 19% above our fair value estimate

Does the January share price for Centessa Pharmaceuticals plc (NASDAQ:CNTA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Centessa Pharmaceuticals

Crunching The Numbers

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF ($, Millions)  -US$159.9m -US$183.4m -US$212.2m -US$129.3m US$85.6m US$121.2m US$157.4m US$191.6m US$222.2m US$248.8m Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Analyst x2 Analyst x2 Est @ 41.58% Est @ 29.89% Est @ 21.71% Est @ 15.98% Est @ 11.97% Present Value ($, Millions) Discounted @ 6.8%  -US$150 -US$161 -US$174 -US$99.3 US$61.5 US$81.5 US$99.1 US$113 US$123 US$129

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$23m

Story Continues

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$249m× (1 + 2.6%) ÷ (6.8%– 2.6%) = US$6.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$6.1b÷ ( 1 + 6.8%)10= US$3.1b

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$3.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$16.8, the company appears quite good value at a 30% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.NasdaqGS:CNTA Discounted Cash Flow January 1st 2025

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 Centessa Pharmaceuticals 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 6.8%, which is based on a levered beta of 0.868. 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 Centessa Pharmaceuticals

Strength

Debt is well covered by earnings.

Weakness

Shareholders have been diluted in the past year.

Opportunity

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

Trading below our estimate of fair value by more than 20%.

Threat

Debt is not well covered by operating cash flow.

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 shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Centessa Pharmaceuticals, there are three important aspects you should consider:

Risks: For instance, we've identified  3 warning signs for Centessa Pharmaceuticals that you should be aware of. Future Earnings: How does CNTA'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. 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 NASDAQGS every day. If you want to find the calculation for other stocks 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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