Stock Analysis

Are Investors Undervaluing Star Cement Limited (NSE:STARCEMENT) By 32%?

NSEI:STARCEMENT
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Today we will run through one way of estimating the intrinsic value of Star Cement Limited (NSE:STARCEMENT) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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.

View our latest analysis for Star Cement

The calculation

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. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (₹, Millions) ₹1.42b ₹313.9m ₹2.75b ₹3.66b ₹4.59b ₹5.50b ₹6.39b ₹7.25b ₹8.08b ₹8.91b
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x2 Est @ 33.17% Est @ 25.38% Est @ 19.92% Est @ 16.1% Est @ 13.43% Est @ 11.56% Est @ 10.25%
Present Value (₹, Millions) Discounted @ 15% ₹1.2k ₹238 ₹1.8k ₹2.1k ₹2.3k ₹2.4k ₹2.4k ₹2.4k ₹2.3k ₹2.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹19b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 7.2%. We discount the terminal cash flows to today's value at a cost of equity of 15%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ₹8.9b× (1 + 7.2%) ÷ (15%– 7.2%) = ₹124b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹124b÷ ( 1 + 15%)10= ₹31b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹50b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₹83.6, the company appears quite good value at a 32% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NSEI:STARCEMENT Discounted Cash Flow October 15th 2020

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 Star Cement 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 15%, which is based on a levered beta of 0.811. 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.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Star Cement, we've put together three additional factors you should further research:

  1. Risks: Every company has them, and we've spotted 1 warning sign for Star Cement you should know about.
  2. Future Earnings: How does STARCEMENT'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.
  3. Other High Quality Alternatives: Do you like a good all-rounder? 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 updates its DCF calculation for every Indian stock every day, so if you want to find the intrinsic value of any other stock just search here.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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