Calculating The Fair Value Of Innoviva, Inc. (NASDAQ:INVA)

Key Insights

• Innoviva's estimated fair value is US$19.59 based on 2 Stage Free Cash Flow to Equity

• Current share price of US$16.04 suggests Innoviva is potentially trading close to its fair value

• Industry average discount to fair value of 32% suggests Innoviva's peers are currently trading at a higher discount

In this article we are going to estimate the intrinsic value of Innoviva, Inc. (NASDAQ:INVA) 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

See our latest analysis for Innoviva

Is Innoviva Fairly Valued?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$98.8m	US$75.2m	US$63.1m	US$56.5m	US$52.8m	US$50.7m	US$49.7m	US$49.3m	US$49.4m	US$49.9m
Growth Rate Estimate Source	Est @ -35.14%	Est @ -23.88%	Est @ -16.01%	Est @ -10.49%	Est @ -6.63%	Est @ -3.93%	Est @ -2.03%	Est @ -0.71%	Est @ 0.22%	Est @ 0.87%
Present Value ($, Millions) Discounted @ 6.1%	US$93.1	US$66.8	US$52.9	US$44.7	US$39.3	US$35.6	US$32.9	US$30.8	US$29.1	US$27.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$453m

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.4%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$50m× (1 + 2.4%) ÷ (6.1%– 2.4%) = US$1.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.4b÷ ( 1 + 6.1%)¹⁰= US$770m

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$1.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$16.0, the company appears about fair value at a 18% 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

The Assumptions

We would point out that 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 Innoviva 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 6.1%, 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 Innoviva

Strength

• Debt is not viewed as a risk.

Weakness

• Earnings declined over the past year.

Opportunity

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

Threat

• No apparent threats visible for INVA.

Moving On:

Whilst important, the DCF calculation 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Innoviva, we've put together three fundamental factors you should look at:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Innoviva (at least 1 which is a bit unpleasant) , and understanding these should be part of your investment process.

2. Future Earnings: How does INVA'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. 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.