Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Birla Corporation Limited (NSE:BIRLACORPN) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to today’s value. I will use the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in January 2019 so be sure check out the updated calculation by following the link below.
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Step by step through the calculation
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 five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
|Levered FCF (₹, Millions)||₹4.95k||₹5.77k||₹6.72k||₹7.83k||₹9.08k|
|Source||Analyst x1||Est @ 16.48%||Est @ 16.48%||Est @ 16.48%||Est @ 16%, capped from 16.48%|
|Present Value Discounted @ 15.76%||₹4.28k||₹4.31k||₹4.33k||₹4.36k||₹4.37k|
Present Value of 5-year Cash Flow (PVCF)= ₹22b
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (7.6%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 15.8%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = ₹9.1b × (1 + 7.6%) ÷ (15.8% – 7.6%) = ₹119b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = ₹119b ÷ ( 1 + 15.8%)5 = ₹57b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is ₹79b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of ₹1026.22. Compared to the current share price of ₹532.4, the stock is quite good value at a 48% discount to what it is available for right now.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Birla as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 15.8%, which is based on a levered beta of 1.102. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For BIRLACORPN, I’ve put together three important factors you should look at:
- Financial Health: Does BIRLACORPN have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does BIRLACORPN’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of BIRLACORPN? 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 for every stock on the NSE every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.