A Look At The Intrinsic Value Of A2Z Infra Engineering Limited (NSE:A2ZINFRA)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, A2Z Infra Engineering fair value estimate is ₹6.71
• A2Z Infra Engineering's ₹7.45 share price indicates it is trading at similar levels as its fair value estimate
• When compared to theindustry average discount of -450%, A2Z Infra Engineering's competitors seem to be trading at a greater premium to fair value

Does the August share price for A2Z Infra Engineering Limited (NSE:A2ZINFRA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

Check out our latest analysis for A2Z Infra Engineering

What's The Estimated Valuation?

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 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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₹, Millions)	₹185.5m	₹203.7m	₹221.9m	₹240.2m	₹258.9m	₹278.3m	₹298.6m	₹319.8m	₹342.2m	₹366.0m
Growth Rate Estimate Source	Est @ 11.11%	Est @ 9.81%	Est @ 8.89%	Est @ 8.25%	Est @ 7.81%	Est @ 7.49%	Est @ 7.27%	Est @ 7.12%	Est @ 7.01%	Est @ 6.94%
Present Value (₹, Millions) Discounted @ 23%	₹150	₹134	₹118	₹104	₹90.4	₹78.7	₹68.4	₹59.4	₹51.5	₹44.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹899m

After calculating the present value of future cash flows in the initial 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 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) = ₹366m× (1 + 6.8%) ÷ (23%– 6.8%) = ₹2.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹2.3b÷ ( 1 + 23%)¹⁰= ₹286m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹1.2b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹7.5, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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. 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 A2Z Infra Engineering 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.

SWOT Analysis for A2Z Infra Engineering

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. 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 A2Z Infra Engineering, there are three important elements you should explore:

1. Risks: To that end, you should learn about the 2 warning signs we've spotted with A2Z Infra Engineering (including 1 which doesn't sit too well with us) .
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 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.