A Look At The Fair Value Of Firstsource Solutions Limited (NSE:FSL)

Key Insights

• The projected fair value for Firstsource Solutions is ₹292 based on 2 Stage Free Cash Flow to Equity
• Current share price of ₹343 suggests Firstsource Solutions is potentially trading close to its fair value
• Analyst price target for FSL is ₹333, which is 14% above our fair value estimate

Does the October share price for Firstsource Solutions Limited (NSE:FSL) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Firstsource Solutions

The Calculation

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (₹, Millions)	₹5.63b	₹7.75b	₹9.54b	₹12.4b	₹14.8b	₹17.0b	₹19.2b	₹21.3b	₹23.4b	₹25.4b
Growth Rate Estimate Source	Analyst x3	Analyst x7	Analyst x5	Analyst x1	Est @ 18.94%	Est @ 15.27%	Est @ 12.70%	Est @ 10.90%	Est @ 9.64%	Est @ 8.76%
Present Value (₹, Millions) Discounted @ 13%	₹5.0k	₹6.1k	₹6.6k	₹7.6k	₹8.0k	₹8.2k	₹8.2k	₹8.0k	₹7.8k	₹7.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹73b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (6.7%) 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 13%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = ₹25b× (1 + 6.7%) ÷ (13%– 6.7%) = ₹434b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹434b÷ ( 1 + 13%)¹⁰= ₹129b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹202b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₹343, 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.

The Assumptions

Now 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 Firstsource Solutions 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 13%, which is based on a levered beta of 0.917. 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 Firstsource Solutions

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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 Firstsource Solutions, there are three further elements you should further research:

1. Risks: Be aware that Firstsource Solutions is showing 3 warning signs in our investment analysis , you should know about...
2. Future Earnings: How does FSL'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 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. 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.