Calculating The Fair Value Of IRB Infrastructure Developers Limited (NSE:IRB)
- IRB Infrastructure Developers' estimated fair value is ₹28.56 based on 2 Stage Free Cash Flow to Equity
- With ₹24.80 share price, IRB Infrastructure Developers appears to be trading close to its estimated fair value
- Our fair value estimate is 8.7% lower than IRB Infrastructure Developers' analyst price target of ₹31.27
Does the March share price for IRB Infrastructure Developers Limited (NSE:IRB) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
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.
See our latest analysis for IRB Infrastructure Developers
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 start off with, we need to estimate the next ten years of cash flows. 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, 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
|Levered FCF (₹, Millions)||₹50.0b||₹23.0b||₹24.6b||₹26.1b||₹27.9b||₹29.7b||₹31.7b||₹33.8b||₹36.1b||₹38.5b|
|Growth Rate Estimate Source||Analyst x3||Analyst x4||Analyst x3||Est @ 6.41%||Est @ 6.53%||Est @ 6.61%||Est @ 6.67%||Est @ 6.71%||Est @ 6.74%||Est @ 6.76%|
|Present Value (₹, Millions) Discounted @ 21%||₹41.3k||₹15.6k||₹13.8k||₹12.1k||₹10.7k||₹9.4k||₹8.3k||₹7.3k||₹6.4k||₹5.6k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹130b
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 21%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = ₹39b× (1 + 6.8%) ÷ (21%– 6.8%) = ₹286b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹286b÷ ( 1 + 21%)10= ₹42b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹172b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹24.8, the company appears about fair value at a 13% discount to where the stock price trades currently. 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.
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. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 IRB Infrastructure Developers 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 21%, which is based on a levered beta of 1.476. 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 IRB Infrastructure Developers
- Earnings growth over the past year exceeded the industry.
- Interest payments on debt are not well covered.
- Dividend is low compared to the top 25% of dividend payers in the Construction market.
- Annual earnings are forecast to grow faster than the Indian market.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Revenue is forecast to grow slower than 20% per year.
Although the valuation of a company is important, it is only one of many factors that you need to assess 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. 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 IRB Infrastructure Developers, we've put together three essential items you should look at:
- Risks: Every company has them, and we've spotted 3 warning signs for IRB Infrastructure Developers (of which 1 is significant!) you should know about.
- Future Earnings: How does IRB'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.
- 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.
Valuation is complex, but we're helping make it simple.
Find out whether IRB Infrastructure Developers is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.
IRB Infrastructure Developers
IRB Infrastructure Developers Limited engages in the construction, development, operation, and maintenance of roads and highways on build-operate-transfer (BOT) basis in India.
Good value with proven track record.