Are Investors Undervaluing Mangalore Refinery and Petrochemicals Limited (NSE:MRPL) By 31%?

Key Insights

• The projected fair value for Mangalore Refinery and Petrochemicals is ₹147 based on 2 Stage Free Cash Flow to Equity
• Mangalore Refinery and Petrochemicals' ₹101 share price signals that it might be 31% undervalued
• The ₹89.73 analyst price target for MRPL is 39% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Mangalore Refinery and Petrochemicals Limited (NSE:MRPL) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. 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 Mangalore Refinery and Petrochemicals

Step By Step Through The Calculation

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. 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₹, Millions)	₹33.4b	₹48.8b	₹46.7b	₹46.2b	₹46.8b	₹48.2b	₹50.2b	₹52.7b	₹55.6b	₹58.8b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -4.29%	Est @ -0.97%	Est @ 1.35%	Est @ 2.97%	Est @ 4.11%	Est @ 4.90%	Est @ 5.46%	Est @ 5.85%
Present Value (₹, Millions) Discounted @ 21%	₹27.7k	₹33.5k	₹26.6k	₹21.8k	₹18.3k	₹15.6k	₹13.5k	₹11.7k	₹10.3k	₹9.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹188b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 21%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₹59b× (1 + 6.8%) ÷ (21%– 6.8%) = ₹452b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹452b÷ ( 1 + 21%)¹⁰= ₹69b

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 ₹257b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₹101, the company appears quite undervalued at a 31% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

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. 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 Mangalore Refinery and Petrochemicals 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 21%, which is based on a levered beta of 1.668. 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 Mangalore Refinery and Petrochemicals

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Mangalore Refinery and Petrochemicals, there are three further aspects you should assess:

1. Risks: As an example, we've found 2 warning signs for Mangalore Refinery and Petrochemicals (1 is a bit concerning!) that you need to consider before investing here.
2. Future Earnings: How does MRPL'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

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.