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I am going to run you through how I calculated the intrinsic value of Welspun India Limited (NSE:WELSPUNIND) by taking the expected future cash flows and discounting them to today’s value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not December 2018 then I highly recommend you check out the latest calculation for Welspun India by following the link below.

Check out our latest analysis for Welspun India

Crunching the numbers

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. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow forecast

Present Value of 5-year Cash Flow (PVCF)= ₹16b

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 (7.7%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 13.5%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = ₹4.5b × (1 + 7.7%) ÷ (13.5% – 7.7%) = ₹84b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = ₹84b ÷ ( 1 + 13.5%)⁵ = ₹44b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is ₹60b. 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 ₹59.88. Compared to the current share price of ₹60.05, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.

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. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Welspun India 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 13.5%, which is based on a levered beta of 0.800. 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.