Is ExlService Holdings, Inc. (NASDAQ:EXLS) Expensive For A Reason? A Look At Its Intrinsic Value
Key Insights
Using the 2 Stage Free Cash Flow to Equity, ExlService Holdings fair value estimate is US$126
Current share price of US$170 suggests ExlService Holdings is potentially 35% overvalued
The US$185 analyst price target for EXLS is 47% more than our estimate of fair value
How far off is ExlService Holdings, Inc. (NASDAQ:EXLS) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for ExlService Holdings
Crunching The Numbers
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$207.3m | US$229.9m | US$246.6m | US$260.6m | US$272.6m | US$283.1m | US$292.5m | US$301.1m | US$309.2m | US$316.9m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Est @ 7.25% | Est @ 5.70% | Est @ 4.61% | Est @ 3.85% | Est @ 3.31% | Est @ 2.94% | Est @ 2.68% | Est @ 2.50% |
Present Value ($, Millions) Discounted @ 8.2% | US$192 | US$196 | US$195 | US$190 | US$184 | US$176 | US$168 | US$160 | US$152 | US$144 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.8b
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 (2.1%) 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 8.2%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$317m× (1 + 2.1%) ÷ (8.2%– 2.1%) = US$5.3b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.3b÷ ( 1 + 8.2%)10= US$2.4b
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$4.2b. 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$170, the company appears potentially overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Important Assumptions
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 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 ExlService Holdings 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 8.2%, which is based on a levered beta of 1.033. 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 ExlService Holdings
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Weakness
Earnings growth over the past year is below its 5-year average.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual revenue is forecast to grow faster than the American market.
Threat
Annual earnings are forecast to grow slower than the American market.
Looking Ahead:
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 lower than the current share price? For ExlService Holdings, we've put together three essential aspects you should look at:
Risks: For instance, we've identified 1 warning sign for ExlService Holdings that you should be aware of.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for EXLS's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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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