Calculating The Intrinsic Value Of Bright Solar Limited (NSE:BRIGHT)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Bright Solar Limited (NSE:BRIGHT) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Bright Solar

Is Bright Solar fairly valued?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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) forecast

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (₹, Millions)	₹5.36m	₹5.81m	₹6.27m	₹6.74m	₹7.23m	₹7.75m	₹8.29m	₹8.86m	₹9.47m	₹10.1m
Growth Rate Estimate Source	Est @ 9.07%	Est @ 8.37%	Est @ 7.88%	Est @ 7.53%	Est @ 7.29%	Est @ 7.12%	Est @ 7.01%	Est @ 6.92%	Est @ 6.86%	Est @ 6.82%
Present Value (₹, Millions) Discounted @ 14%	₹4.7	₹4.4	₹4.2	₹3.9	₹3.7	₹3.5	₹3.2	₹3.0	₹2.8	₹2.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹36m

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 (6.7%) 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 14%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = ₹10m× (1 + 6.7%) ÷ (14%– 6.7%) = ₹141m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹141m÷ ( 1 + 14%)¹⁰= ₹37m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is ₹73m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₹4.1, 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.

Important 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 Bright Solar 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 14%, which is based on a levered beta of 1.189. 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:

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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Bright Solar, there are three fundamental items you should assess:

1. Risks: For example, we've discovered 4 warning signs for Bright Solar (3 don't sit too well with us!) 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.