Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Does the June share price for ARSS Infrastructure Projects Limited (NSE:ARSSINFRA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's 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.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
Levered FCF (₹, Millions)
₹124.63
₹136.03
₹147.83
₹160.15
₹173.11
₹186.85
₹201.46
₹217.05
₹233.72
₹251.58
Growth Rate Estimate Source
Est @ 9.83%
Est @ 9.15%
Est @ 8.67%
Est @ 8.33%
Est @ 8.1%
Est @ 7.93%
Est @ 7.82%
Est @ 7.74%
Est @ 7.68%
Est @ 7.64%
Present Value (₹, Millions) Discounted @ 24.75%
₹99.90
₹87.41
₹76.14
₹66.12
₹57.30
₹49.57
₹42.85
₹37.00
₹31.94
₹27.56
Present Value of 10-year Cash Flow (PVCF)= ₹575.80m
"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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 7.6%. We discount the terminal cash flows to today's value at a cost of equity of 24.8%.
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = ₹₹1.6b ÷ ( 1 + 24.8%)10 = ₹172.33m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹748.13m. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of ₹33.03. Compared to the current share price of ₹39.1, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
NSEI:ARSSINFRA Intrinsic value, June 10th 2019
The assumptions
We would 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 these result, have a go at the calculation yourself and play with the assumptions. 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 ARSS Infrastructure Projects 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 24.8%, which is based on a levered beta of 2. 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:
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. 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 ARSS Infrastructure Projects, I've put together three pertinent aspects you should further examine:
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of ARSSINFRA? 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 valuation for every stock on the NSE every day. If you want to find the calculation for other stocks just search here.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.
