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A Look At The Fair Value Of Eli Lilly and Company (NYSE:LLY)

Key Insights

  • Eli Lilly's estimated fair value is US$598 based on 2 Stage Free Cash Flow to Equity

  • With US$592 share price, Eli Lilly appears to be trading close to its estimated fair value

  • Our fair value estimate is 2.4% lower than Eli Lilly's analyst price target of US$613

In this article we are going to estimate the intrinsic value of Eli Lilly and Company (NYSE:LLY) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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See our latest analysis for Eli Lilly

Step By Step Through The Calculation

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.

Generally we assume that a dollar today is more valuable 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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$8.40b

US$11.4b

US$16.1b

US$19.1b

US$21.3b

US$23.2b

US$24.8b

US$26.1b

US$27.3b

US$28.3b

Growth Rate Estimate Source

Analyst x9

Analyst x9

Analyst x4

Analyst x4

Est @ 11.61%

Est @ 8.79%

Est @ 6.82%

Est @ 5.44%

Est @ 4.47%

Est @ 3.80%

Present Value ($, Millions) Discounted @ 6.2%

US$7.9k

US$10.1k

US$13.4k

US$15.0k

US$15.8k

US$16.1k

US$16.2k

US$16.1k

US$15.9k

US$15.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$142b

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 2.2%. 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$724b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$724b÷ ( 1 + 6.2%)10= US$396b

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$538b. 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$592, the company appears about fair value at a 1.1% 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.

dcf
dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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

  • Debt is well covered by earnings and cashflows.

Weakness

  • Earnings declined over the past year.

  • 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. DCF models are not the be-all and end-all of investment valuation. 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. For Eli Lilly, we've compiled three fundamental elements you should look at:

  1. Risks: As an example, we've found 2 warning signs for Eli Lilly that you need to consider before investing here.

  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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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.

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.