Calculating The Fair Value Of H.G. Infra Engineering Limited (NSE:HGINFRA)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, H.G. Infra Engineering fair value estimate is ₹1,044
• With ₹1,186 share price, H.G. Infra Engineering appears to be trading close to its estimated fair value
• The ₹1,645 analyst price target for HGINFRA is 58% more than our estimate of fair value

Does the May share price for H.G. Infra Engineering Limited (NSE:HGINFRA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

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The Method

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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (₹, Millions)	₹5.37b	₹6.42b	₹6.78b	₹7.16b	₹7.58b	₹8.05b	₹8.56b	₹9.11b	₹9.70b	₹10.3b
Growth Rate Estimate Source	Analyst x3	Analyst x4	Analyst x3	Est @ 5.54%	Est @ 5.90%	Est @ 6.14%	Est @ 6.32%	Est @ 6.44%	Est @ 6.52%	Est @ 6.58%
Present Value (₹, Millions) Discounted @ 15%	₹4.7k	₹4.8k	₹4.4k	₹4.1k	₹3.7k	₹3.4k	₹3.2k	₹2.9k	₹2.7k	₹2.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹37b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 15%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = ₹10b× (1 + 6.7%) ÷ (15%– 6.7%) = ₹130b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹130b÷ ( 1 + 15%)¹⁰= ₹32b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹68b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₹1.2k, 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

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 H.G. 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 15%, which is based on a levered beta of 1.170. 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.

See our latest analysis for H.G. Infra Engineering

SWOT Analysis for H.G. Infra Engineering

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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 H.G. Infra Engineering, there are three fundamental factors you should consider:

1. Risks: We feel that you should assess the 1 warning sign for H.G. Infra Engineering we've flagged before making an investment in the company.
2. Future Earnings: How does HGINFRA'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. 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.