Calculating The Intrinsic Value Of Eastern Silk Industries Limited (NSE:EASTSILK)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Eastern Silk Industries fair value estimate is ₹2.68
• Eastern Silk Industries' ₹2.40 share price indicates it is trading at similar levels as its fair value estimate
• Eastern Silk Industries' peers are currently trading at a premium of 1,401% on average

In this article we are going to estimate the intrinsic value of Eastern Silk Industries Limited (NSE:EASTSILK) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Eastern Silk Industries

The Method

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 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.

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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₹, Millions)	₹32.7m	₹36.1m	₹39.5m	₹42.9m	₹46.3m	₹49.8m	₹53.5m	₹57.4m	₹61.4m	₹65.7m
Growth Rate Estimate Source	Est @ 12.03%	Est @ 10.45%	Est @ 9.34%	Est @ 8.57%	Est @ 8.03%	Est @ 7.65%	Est @ 7.38%	Est @ 7.19%	Est @ 7.06%	Est @ 6.97%
Present Value (₹, Millions) Discounted @ 23%	₹26.5	₹23.7	₹21.0	₹18.5	₹16.2	₹14.1	₹12.3	₹10.7	₹9.2	₹8.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹160m

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) = ₹66m× (1 + 6.8%) ÷ (23%– 6.8%) = ₹421m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹421m÷ ( 1 + 23%)¹⁰= ₹51m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹211m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₹2.4, the company appears about fair value at a 10% discount to where the stock price trades currently. 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. 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 Eastern Silk Industries 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.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. 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 Eastern Silk Industries, we've put together three additional factors you should look at:

1. Risks: We feel that you should assess the 4 warning signs for Eastern Silk Industries (3 make us uncomfortable!) we've flagged before making 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. 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.