Estimating The Fair Value Of Aries Agro Limited (NSE:ARIES)

By
Simply Wall St
Published
January 25, 2022
NSEI:ARIES
Source: Shutterstock

Does the January share price for Aries Agro Limited (NSE:ARIES) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. 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 Aries Agro

The method

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (₹, Millions) ₹316.6m ₹248.3m ₹215.9m ₹200.5m ₹194.5m ₹194.4m ₹198.3m ₹205.0m ₹214.1m ₹225.0m
Growth Rate Estimate Source Est @ -33.7% Est @ -21.56% Est @ -13.07% Est @ -7.13% Est @ -2.97% Est @ -0.06% Est @ 1.98% Est @ 3.41% Est @ 4.41% Est @ 5.11%
Present Value (₹, Millions) Discounted @ 14% ₹277 ₹191 ₹145 ₹118 ₹100 ₹88.0 ₹78.6 ₹71.2 ₹65.1 ₹60.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹1.2b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (6.7%) 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)= FCF2031 × (1 + g) ÷ (r – g) = ₹225m× (1 + 6.7%) ÷ (14%– 6.7%) = ₹3.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹3.2b÷ ( 1 + 14%)10= ₹866m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹2.1b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₹148, the company appears about fair value at a 6.5% 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.

dcf
NSEI:ARIES Discounted Cash Flow January 25th 2022

Important 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Aries Agro 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 1.187. 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:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 Aries Agro, we've put together three relevant elements you should look at:

  1. Risks: Be aware that Aries Agro is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
  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. 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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