How far off is Graphite India Limited (NSE:GRAPHITE) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. I will use the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. 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. Please also note that this article was written in June 2018 so be sure check out the updated calculation by following the link below. View out our latest analysis for Graphite India
Step by step through the calculation
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. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. 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
|Levered FCF (₹, Millions)||₹6.07k||₹8.41k||₹17.48k||₹19.46k||₹21.67k|
|Source||Analyst x1||Analyst x2||Analyst x2||Extrapolated @ (11.36%)||Extrapolated @ (11.36%)|
|Present Value Discounted @ 15.13%||₹5.27k||₹6.34k||₹11.45k||₹11.08k||₹10.71k|
Present Value of 5-year Cash Flow (PVCF)= ₹44.85b
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 15.1%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = ₹21.67b × (1 + 7.7%) ÷ (15.1% – 7.7%) = ₹315.46b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = ₹315.46b ÷ ( 1 + 15.1%)5 = ₹155.95b
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 ₹200.81b. 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 ₹1027.4. Relative to the current share price of ₹794.9, the stock is about right, perhaps slightly undervalued at a 22.63% discount to what it is available for right now.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Graphite 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 15.1%, which is based on a levered beta of 1.018. 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.
Although the valuation of a company is important, 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 GRAPHITE, I’ve put together three pertinent factors you should look at:
- Financial Health: Does GRAPHITE 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 GRAPHITE’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 GRAPHITE? 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 does a DCF calculation for every IN stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see pass 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.