A Look At The Fair Value Of Morepen Laboratories Limited (NSE:MOREPENLAB)
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Today we will run through one way of estimating the intrinsic value of Morepen Laboratories Limited (NSE:MOREPENLAB) by taking the expected future cash flows and discounting them to their present value. I will use the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Check out our latest analysis for Morepen Laboratories
The method
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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, 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
2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | |
Levered FCF (₹, Millions) | ₹597.54 | ₹654.45 | ₹712.90 | ₹773.61 | ₹837.25 | ₹904.43 | ₹975.72 | ₹1.05k | ₹1.13k | ₹1.22k |
Growth Rate Estimate Source | Est @ 10.37% | Est @ 9.52% | Est @ 8.93% | Est @ 8.52% | Est @ 8.23% | Est @ 8.02% | Est @ 7.88% | Est @ 7.78% | Est @ 7.71% | Est @ 7.66% |
Present Value (₹, Millions) Discounted @ 14.43% | ₹522.19 | ₹499.80 | ₹475.78 | ₹451.19 | ₹426.73 | ₹402.84 | ₹379.79 | ₹357.73 | ₹336.73 | ₹316.82 |
Present Value of 10-year Cash Flow (PVCF)= ₹4.17b
"Est" = FCF growth rate estimated by Simply Wall St
After calculating the present value of future cash flows in the intial 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 10-year government bond rate (7.6%) 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 14.4%.
Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = ₹1.2b × (1 + 7.6%) ÷ (14.4% – 7.6%) = ₹19b
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = ₹₹19b ÷ ( 1 + 14.4%)10 = ₹4.95b
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 ₹9.12b. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of ₹20.28. Relative to the current share price of ₹18, the company appears about fair value at a 11% 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.
Important assumptions
Now 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 Morepen Laboratories 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 14.4%, 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.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 Morepen Laboratories, I've put together three further factors you should further examine:
Financial Health: Does MOREPENLAB 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.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of MOREPENLAB? 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 IN stock every day, so if you want to find the intrinsic value of any other stock just search here.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
