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IRB Infrastructure Developers Limited (NSE:IRB) Shares Could Be 29% Above Their Intrinsic Value Estimate
Key Insights
- IRB Infrastructure Developers' estimated fair value is ₹44.36 based on 2 Stage Free Cash Flow to Equity
- IRB Infrastructure Developers' ₹57.30 share price signals that it might be 29% overvalued
- The ₹61.40 analyst price target for IRB is 38% more than our estimate of fair value
In this article we are going to estimate the intrinsic value of IRB Infrastructure Developers Limited (NSE:IRB) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
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.
Check out our latest analysis for IRB Infrastructure Developers
Step By Step Through The Calculation
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. 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
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (₹, Millions) | ₹21.8b | ₹35.0b | ₹34.3b | ₹34.6b | ₹35.5b | ₹36.8b | ₹38.5b | ₹40.6b | ₹42.9b | ₹45.4b |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x2 | Est @ 0.73% | Est @ 2.52% | Est @ 3.78% | Est @ 4.66% | Est @ 5.27% | Est @ 5.70% | Est @ 6.01% |
Present Value (₹, Millions) Discounted @ 17% | ₹18.7k | ₹25.8k | ₹21.7k | ₹18.7k | ₹16.5k | ₹14.7k | ₹13.2k | ₹11.9k | ₹10.8k | ₹9.8k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹162b
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 17%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = ₹45b× (1 + 6.7%) ÷ (17%– 6.7%) = ₹492b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹492b÷ ( 1 + 17%)10= ₹106b
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 ₹268b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₹57.3, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 17%, which is based on a levered beta of 1.262. 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
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- Interest payments on debt are not well covered.
- Dividend is low compared to the top 25% of dividend payers in the Construction market.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow faster than the Indian market.
- Debt is not well covered by operating cash flow.
- Annual revenue is forecast to grow slower than the Indian market.
Looking Ahead:
Whilst important, the DCF calculation 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. Why is the intrinsic value lower than the current share price? For IRB Infrastructure Developers, there are three further aspects you should explore:
- Risks: For example, we've discovered 4 warning signs for IRB Infrastructure Developers (1 is significant!) that you should be aware of before investing here.
- 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 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NSEI every day. If you want to find the calculation for other stocks just search here.
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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About NSEI:IRB
IRB Infrastructure Developers
Engages in the infrastructure development business in India.
Undervalued with reasonable growth potential.