Calculating The Fair Value Of Tata Steel Limited (NSE:TATASTEEL)

Simply Wall St.

Fri, Oct 12, 2018, 12:14 AM

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Tata Steel Limited (NSE:TATASTEEL) as an investment opportunity by estimating the company’s future cash flows and discounting them to their present value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! 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 October 2018 so be sure check out the updated calculation by following the link below.

Check out our latest analysis for Tata Steel

Step by step through the calculation

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. 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 this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow estimate

	2019	2020	2021	2022	2023
Levered FCF (₹, Millions)	₹-57.93k	₹98.84k	₹107.72k	₹104.57k	₹101.51k
Source	Analyst x15	Analyst x13	Analyst x6	Est @ -2.93%	Est @ -2.93%
Present Value Discounted @ 19.61%	₹-48.43k	₹69.09k	₹62.95k	₹51.09k	₹41.46k

Present Value of 5-year Cash Flow (PVCF)= ₹176.2b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. 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 (7.7%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 19.6%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = ₹101.5b × (1 + 7.7%) ÷ (19.6% – 7.7%) = ₹920.5b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = ₹920.5b ÷ ( 1 + 19.6%)⁵ = ₹376.0b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is ₹552.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of ₹507.16. Relative to the current share price of ₹583.65, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.

NSEI:TATASTEEL Intrinsic Value Export October 12th 18

Important assumptions

I’d like to 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Tata Steel 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 19.6%, which is based on a levered beta of 1.634. 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.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For TATASTEEL, I’ve put together three relevant factors you should further examine:

Financial Health: Does TATASTEEL 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 TATASTEEL’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 TATASTEEL? 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 editorial-team@simplywallst.com.

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