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

Key Insights

• H.G. Infra Engineering's estimated fair value is ₹1,397 based on 2 Stage Free Cash Flow to Equity
• H.G. Infra Engineering's ₹1,480 share price indicates it is trading at similar levels as its fair value estimate
• The ₹1,691 analyst price target for HGINFRA is 21% more than our estimate of fair value

Does the October 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 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

View our latest analysis for H.G. Infra Engineering

The Method

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. 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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (₹, Millions)	₹5.98b	₹5.95b	₹7.31b	₹7.98b	₹8.66b	₹9.35b	₹10.1b	₹10.8b	₹11.6b	₹12.4b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x2	Est @ 9.24%	Est @ 8.48%	Est @ 7.95%	Est @ 7.57%	Est @ 7.31%	Est @ 7.13%	Est @ 7.00%
Present Value (₹, Millions) Discounted @ 14%	₹5.2k	₹4.6k	₹4.9k	₹4.7k	₹4.5k	₹4.2k	₹4.0k	₹3.8k	₹3.5k	₹3.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹43b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 6.7%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = ₹12b× (1 + 6.7%) ÷ (14%– 6.7%) = ₹180b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹180b÷ ( 1 + 14%)¹⁰= ₹48b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹91b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ₹1.5k, 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 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 14%, which is based on a levered beta of 1.081. 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 H.G. Infra Engineering

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For H.G. Infra Engineering, we've put together three essential items you should explore:

1. Risks: Be aware that H.G. Infra Engineering is showing 1 warning sign in our investment analysis , you should know about...
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 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!

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.