Hindalco Industries Limited (NSE:HINDALCO) Is Trading At A 34.86% Discount

Simply Wall St.

Wed, Dec 5, 2018, 5:17 PM

I am going to run you through how I calculated the intrinsic value of Hindalco Industries Limited (NSE:HINDALCO) by projecting its future cash flows and then discounting them to today’s value. I will be 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. If you are reading this and its not December 2018 then I highly recommend you check out the latest calculation for Hindalco Industries by following the link below.

View our latest analysis for Hindalco Industries

The method

I’m 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 perpetual stable growth rate. To start off with we need to estimate 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

	2019	2020	2021	2022	2023
Levered FCF (₹, Millions)	₹51.60k	₹79.03k	₹95.95k	₹101.75k	₹107.90k
Source	Analyst x11	Analyst x10	Analyst x7	Est @ 6.05%	Est @ 6.05%
Present Value Discounted @ 17.44%	₹43.94k	₹57.30k	₹59.24k	₹53.49k	₹48.30k

Present Value of 5-year Cash Flow (PVCF)= ₹262b

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 7.7%. We discount this to today’s value at a cost of equity of 17.4%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = ₹108b × (1 + 7.7%) ÷ (17.4% – 7.7%) = ₹1.2t

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = ₹1.2t ÷ ( 1 + 17.4%)⁵ = ₹536b

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 ₹798b. In the final step we 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) or ADR then we use the equivalent number. This results in an intrinsic value of ₹358.21. Relative to the current share price of ₹233.35, the stock is quite undervalued at a 35% discount to what it is available for right now.

NSEI:HINDALCO Intrinsic Value Export December 6th 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 Hindalco Industries 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 17.4%, which is based on a levered beta of 1.335. 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:

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. What is the reason for the share price to differ from the intrinsic value? For HINDALCO, I’ve compiled three essential factors you should look at:

Financial Health: Does HINDALCO 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 HINDALCO’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 HINDALCO? 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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