Estimating The Intrinsic Value Of Tata Coffee Limited (NSE:TATACOFFEE)

Today we will run through one way of estimating the intrinsic value of Tata Coffee Limited (NSE:TATACOFFEE) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Tata Coffee

Is Tata Coffee fairly valued?

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 begin with, we have to get estimates of 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (₹, Millions)	₹1.17b	₹1.25b	₹1.33b	₹1.42b	₹1.52b	₹1.62b	₹1.73b	₹1.85b	₹1.98b	₹2.12b
Growth Rate Estimate Source	Est @ 6.28%	Est @ 6.49%	Est @ 6.63%	Est @ 6.73%	Est @ 6.8%	Est @ 6.85%	Est @ 6.88%	Est @ 6.9%	Est @ 6.92%	Est @ 6.93%
Present Value (₹, Millions) Discounted @ 14%	₹1.0k	₹964	₹902	₹846	₹793	₹744	₹698	₹655	₹615	₹578

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹7.8b

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 (7.0%) 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 14%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ₹2.1b× (1 + 7.0%) ÷ (14%– 7.0%) = ₹33b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹33b÷ ( 1 + 14%)¹⁰= ₹8.9b

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 ₹17b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹105, 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.

Important assumptions

Now 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 Tata Coffee 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 14%, which is based on a levered beta of 0.819. 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.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Tata Coffee, there are three essential factors you should explore:

1. Risks: For example, we've discovered 1 warning sign for Tata Coffee that you should be aware of before investing here.
2. Future Earnings: How does TATACOFFEE'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.

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This article by Simply Wall St is general in nature. 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.
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