Today we will run through one method of estimating the intrinsic value of HG Infra Engineering Limited (NSE: HGINFRA) by taking the expected future cash flows and discounting them to their present value. right now. This is done using the Discounted Cash Flow (DCF) model. Don’t bother with the jargon, the math behind it is pretty simple.
We generally believe that the value of a company is the present value of all the money it generates in the future. However, DCF is just one meter of evaluation among many, and it is not without flaws. If you want to learn more about discounted cash flow, the philosophy behind this account can be read in detail in the Simply Wall St. analysis module.
Check out our latest analysis for HG Infra Engineering
The enumeration
We are going to use a two-stage DCF model, which, as the name suggests, takes into account two growth stages. In the first stage there is a higher growth period that goes down to the value of the destination, captured in the second period ‘sustainable growth’. First, we need to get estimates of the next ten years of cash flow. We use analysts’ estimates where possible, but where these are not available we deduct the free cash flow (FCF) from the last estimate or the reported value. . We assume that declining free cash flow companies will reduce their rate of decline, and that free cash flow companies will see their growth rate slow, over this period. . We do this to show that growth tends to slow down in the early years than it does in later years.
We generally assume that a dollar today is more valuable than a dollar in the future, so the sum of these future cash flows is reduced to present value:
10-year free cash flow (FCF) forecast
| 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
| Levered FCF (₹, millions) | ₹ 1.17b | ₹ 1.64b | ₹ 1.54b | ₹ 1.73b | ₹ 1.92b | ₹ 2.11b | ₹ 2.30b | ₹ 2.49b | ₹ 2.68b | ₹ 2.89b |
| Estimated source of growth rate | Inspector x1 | Inspector x1 | Inspector x1 | Est @ 12.49% | Est @ 10.83% | Est @ 9.67% | Est @ 8.86% | Est @ 8.29% | Est @ 7.89% | Est @ 7.61% |
| Present value (₹, millions) Discount @ 17% | ₹ 1.0k | ₹ 1.2k | ₹ 973 | ₹ 938 | ₹ 892 | ₹ 839 | ₹ 783 | ₹ 727 | ₹ 673 | ₹ 621 |
(“Est” = FCF growth rate measured by Simply Wall St)
Present value of 10-year Cash Flow (PVCF) = ₹ 8.6b
The second tier is called Terminal Value, which is the cash flow of the business after the first tier. The Gordon Growth formula is used to estimate Completion Value at a future annual growth rate equivalent to the 5-year average of 10-year government bond yields of 7.0%. We reduce the final cash flows to today’s value at a cost of equity of 17%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ₹ 2.9b × (1 + 7.0%) ÷ (17% – 7.0%) = ₹ 32b
Present value of boundary value (PVTV)= Tbh / (1 + r)10= ₹ 32b ÷ (1 + 17%)10= ₹ 6.9b
The total value is the sum of the cash flows for the next ten years plus the discounted discount value, resulting in Total Opportunity Value, which in this case is ₹ 16b. The final step is to divide the equity value by the number of outstanding shares. Compared to the current average price of ₹ 284, the company appears to be around fair value at the time of writing. Remember, however, that this is just an approximate valuation, and like any complex formula – waste in, waste out.
The assumptions
Now the most important input to discounted cash flows is the discount rate, and of course, the actual cash flows. If you do not agree with these results, try calculating them yourself and play with the assumptions. The DCF also does not consider potential business cycling, or a company’s future capital requirements, and therefore does not provide a complete picture of a company’s potential performance. Because we view HG Infra Engineering as potential shareholders, the cost of equity is used as the discount rate, rather than the resulting cost of capital (or average weighted capital cost, WACC). on debt. In this account we have used 17%, which is based on a levered beta of 1.141. Beta is a measure of stock volatility, compared to the market as a whole. We get our beta from the industry average beta of comparable companies globally, with a limit of between 0.8 and 2.0, which is a reasonable range for a stable industry.
Moving On:
While important, in reality DCF calculations are not the only piece of research you will study for a company. DCF models are not exhaustive and final of investment valuation. It would be better if you applied different issues and assumptions and saw how they would affect the valuation of the company. For example, changes in the company’s equity cost or risk-free rate can have a significant impact on the valuation. For HG Infra Engineering, we have put together three other aspects that you should consider:
- Dangers: To that end, you should learn about the 2 warning signs we have seen with HG Infra Engineering (including 1 that cannot be skipped).
- Future earnings: How does HGINFRA’s growth rate compare to its peers and the market in general? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectation chart.
- Other high quality options: Do you like a good rounder? Check out our interactive list of top quality stocks to get an idea of what else out there you might be missing!
PS. Simply put, Wall St updates its DCF calculations for all Indian stocks every day, so if you want to find the intrinsic value of any other stock just search here.
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