Calculating The Intrinsic Value Of Ambica Agarbathies Aroma & Industries Limited (NSE:AMBICAAGAR)

Key Insights

• Ambica Agarbathies Aroma & Industries' estimated fair value is ₹45.06 based on 2 Stage Free Cash Flow to Equity
• With ₹41.00 share price, Ambica Agarbathies Aroma & Industries appears to be trading close to its estimated fair value
• Peers of Ambica Agarbathies Aroma & Industries are currently trading on average at a 681% premium

How far off is Ambica Agarbathies Aroma & Industries Limited (NSE:AMBICAAGAR) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. Our analysis will employ 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 Ambica Agarbathies Aroma & Industries

Crunching The Numbers

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, 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)	₹78.6m	₹86.0m	₹93.5m	₹101.0m	₹108.8m	₹116.9m	₹125.3m	₹134.2m	₹143.5m	₹153.5m
Growth Rate Estimate Source	Est @ 10.62%	Est @ 9.46%	Est @ 8.65%	Est @ 8.08%	Est @ 7.69%	Est @ 7.41%	Est @ 7.21%	Est @ 7.08%	Est @ 6.98%	Est @ 6.92%
Present Value (₹, Millions) Discounted @ 18%	₹66.9	₹62.3	₹57.5	₹52.9	₹48.5	₹44.3	₹40.4	₹36.8	₹33.5	₹30.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹473m

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 18%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₹153m× (1 + 6.8%) ÷ (18%– 6.8%) = ₹1.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹1.5b÷ ( 1 + 18%)¹⁰= ₹301m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹774m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹41.0, the company appears about fair value at a 9.0% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Ambica Agarbathies Aroma & 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 18%, which is based on a levered beta of 1.297. 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 Ambica Agarbathies Aroma & Industries

Moving On:

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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Ambica Agarbathies Aroma & Industries, there are three important aspects you should assess:

1. Risks: We feel that you should assess the 3 warning signs for Ambica Agarbathies Aroma & Industries (2 are concerning!) we've flagged before making an investment in the company.
2. 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!
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.