Is Mangalore Refinery and Petrochemicals Limited (NSE:MRPL) Trading At A 25% Discount?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Mangalore Refinery and Petrochemicals fair value estimate is ₹119
• Mangalore Refinery and Petrochemicals is estimated to be 25% undervalued based on current share price of ₹88.80
• Peers of Mangalore Refinery and Petrochemicals are currently trading on average at a 195% premium

In this article we are going to estimate the intrinsic value of Mangalore Refinery and Petrochemicals Limited (NSE:MRPL) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 Mangalore Refinery and Petrochemicals

Crunching The Numbers

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 begin with, we have to get estimates of 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₹, Millions)	₹25.8b	₹44.9b	₹45.0b	₹46.0b	₹47.6b	₹49.8b	₹52.3b	₹55.3b	₹58.7b	₹62.3b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 0.21%	Est @ 2.18%	Est @ 3.57%	Est @ 4.54%	Est @ 5.22%	Est @ 5.69%	Est @ 6.02%	Est @ 6.26%
Present Value (₹, Millions) Discounted @ 24%	₹20.8k	₹29.3k	₹23.8k	₹19.6k	₹16.4k	₹13.9k	₹11.8k	₹10.1k	₹8.7k	₹7.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹162b

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 24%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₹62b× (1 + 6.8%) ÷ (24%– 6.8%) = ₹394b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹394b÷ ( 1 + 24%)¹⁰= ₹47b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹209b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₹88.8, the company appears a touch undervalued at a 25% 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

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 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 24%, which is based on a levered beta of 1.736. 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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. What is the reason for the share price sitting below the intrinsic value? For Mangalore Refinery and Petrochemicals, there are three additional items you should assess:

1. Risks: For example, we've discovered 3 warning signs for Mangalore Refinery and Petrochemicals (1 is a bit unpleasant!) that you should be aware of 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. 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.