Estimating The Intrinsic Value Of McNally Bharat Engineering Company Limited (NSE:MBECL)

Key Insights

• McNally Bharat Engineering's estimated fair value is ₹2.89 based on 2 Stage Free Cash Flow to Equity
• McNally Bharat Engineering's ₹3.00 share price indicates it is trading at similar levels as its fair value estimate
• When compared to theindustry average discount of -480%, McNally Bharat Engineering's competitors seem to be trading at a greater premium to fair value

Today we will run through one way of estimating the intrinsic value of McNally Bharat Engineering Company Limited (NSE:MBECL) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ 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.

View our latest analysis for McNally Bharat Engineering

Is McNally Bharat Engineering Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₹, Millions)	₹95.4m	₹104.9m	₹114.4m	₹123.9m	₹133.6m	₹143.7m	₹154.2m	₹165.2m	₹176.8m	₹189.1m
Growth Rate Estimate Source	Est @ 11.33%	Est @ 9.96%	Est @ 9.00%	Est @ 8.33%	Est @ 7.86%	Est @ 7.53%	Est @ 7.30%	Est @ 7.14%	Est @ 7.02%	Est @ 6.94%
Present Value (₹, Millions) Discounted @ 23%	₹77.3	₹68.9	₹60.8	₹53.4	₹46.7	₹40.7	₹35.3	₹30.7	₹26.6	₹23.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹464m

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 6.8%. We discount the terminal cash flows to today's value at a cost of equity of 23%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₹189m× (1 + 6.8%) ÷ (23%– 6.8%) = ₹1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹1.2b÷ ( 1 + 23%)¹⁰= ₹148m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹611m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₹3.0, the company appears around fair value 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 McNally Bharat 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 23%, which is based on a levered beta of 2.000. 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 McNally Bharat Engineering

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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 McNally Bharat Engineering, we've compiled three important items you should consider:

1. Risks: You should be aware of the 4 warning signs for McNally Bharat Engineering we've uncovered before considering an investment in the company.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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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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.