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Does the February share price for Kirloskar Oil Engines Limited (NSE:KIRLOSENG) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by taking the foreast future cash flows of the company and discounting them back to today’s value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not February 2019 then I highly recommend you check out the latest calculation for Kirloskar Oil Engines by following the link below.
Crunching the numbers
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF (₹, Millions)||₹613.00||₹1.60k||₹1.81k||₹1.89k||₹1.99k|
|Source||Analyst x1||Analyst x1||Analyst x1||Est @ 4.87%||Est @ 4.87%|
|Present Value Discounted @ 13.51%||₹540.04||₹1.24k||₹1.24k||₹1.14k||₹1.05k|
Present Value of 5-year Cash Flow (PVCF)= ₹5.2b
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 7.6%. We discount this to today’s value at a cost of equity of 13.5%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = ₹2.0b × (1 + 7.6%) ÷ (13.5% – 7.6%) = ₹36b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = ₹36b ÷ ( 1 + 13.5%)5 = ₹19b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is ₹24b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of ₹166.32. Relative to the current share price of ₹166.6, the stock is fair value, maybe slightly overvalued at the time of writing.
I’d like to 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Kirloskar Oil Engines as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 13.5%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For KIRLOSENG, I’ve compiled three key factors you should further examine:
- Financial Health: Does KIRLOSENG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does KIRLOSENG’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: Are there other high quality stocks you could be holding instead of KIRLOSENG? 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 does a DCF calculation for every IN stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.