Calculating The Intrinsic Value Of Automotive Axles Limited (NSE:AUTOAXLES)

Does the March share price for Automotive Axles Limited (NSE:AUTOAXLES) 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. It may sound complicated, but actually it is quite simple!

We generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Automotive Axles

Crunching the numbers

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:

10-year free cash flow (FCF) estimate

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
Levered FCF (₹, Millions) ₹942.5m ₹1.02b ₹1.10b ₹1.18b ₹1.26b ₹1.35b ₹1.44b ₹1.53b ₹1.64b ₹1.74b
Growth Rate Estimate Source Est @ 8.88% Est @ 8.16% Est @ 7.66% Est @ 7.3% Est @ 7.06% Est @ 6.88% Est @ 6.76% Est @ 6.68% Est @ 6.62% Est @ 6.58%
Present Value (₹, Millions) Discounted @ 16% ₹813 ₹759 ₹705 ₹653 ₹603 ₹556 ₹512 ₹471 ₹434 ₹399

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹5.9b

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case we have used the 10-year government bond rate (6.5%) to estimate future growth. In the same way as with the 10-year ‘growth’ period, we discount future cash flows to today’s value, using a cost of equity of 16%.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = ₹1.7b× (1 + 6.5%) ÷ 16%– 6.5%) = ₹20b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹20b÷ ( 1 + 16%)10= ₹4.5b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹10b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of ₹651, the company appears about fair value at a 5.6% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula – garbage in, garbage out.

NSEI:AUTOAXLES Intrinsic value, March 5th 2020
NSEI:AUTOAXLES Intrinsic value, March 5th 2020

Important assumptions

Now 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 Automotive Axles 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 16%, which is based on a levered beta of 1.200. 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:

Whilst important, DCF calculation 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 Automotive Axles, We’ve put together three further aspects you should look at:

  1. Risks: As an example, we’ve found 2 warning signs for Automotive Axles that you need to consider before investing here.
  2. 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!
  3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NSEI every day. If you want to find the calculation for other stocks just search here.

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.

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. Thank you for reading.