Estimating The Fair Value Of Birla Tyres Limited (NSE:BIRLATYRE)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Birla Tyres fair value estimate is ₹4.23
• With ₹4.95 share price, Birla Tyres appears to be trading close to its estimated fair value
• Industry average of 310% suggests Birla Tyres' peers are currently trading at a higher premium to fair value

In this article we are going to estimate the intrinsic value of Birla Tyres Limited (NSE:BIRLATYRE) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Birla Tyres

What's The Estimated Valuation?

We're 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 a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₹, Millions)	₹94.9m	₹104.0m	₹113.0m	₹122.2m	₹131.6m	₹141.4m	₹151.7m	₹162.4m	₹173.8m	₹185.8m
Growth Rate Estimate Source	Est @ 10.75%	Est @ 9.56%	Est @ 8.72%	Est @ 8.13%	Est @ 7.72%	Est @ 7.43%	Est @ 7.23%	Est @ 7.09%	Est @ 6.99%	Est @ 6.92%
Present Value (₹, Millions) Discounted @ 23%	₹76.9	₹68.2	₹60.1	₹52.7	₹46.0	₹40.0	₹34.8	₹30.2	₹26.1	₹22.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹458m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 5-year average of the 10-year government bond yield (6.8%) 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 23%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₹186m× (1 + 6.8%) ÷ (23%– 6.8%) = ₹1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹1.2b÷ ( 1 + 23%)¹⁰= ₹145m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹603m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹5.0, the company appears around fair value at the time of writing. 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Birla Tyres 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 23%, which is based on a levered beta of 2.000. 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.

Moving On:

Whilst important, the DCF calculation 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. For Birla Tyres, there are three important items you should explore:

1. Risks: For example, we've discovered 5 warning signs for Birla Tyres (4 shouldn't be ignored!) that you should be aware of before investing here.
2. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.