In this article we are going to estimate the intrinsic value of HIL Limited (NSE:HIL) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for HIL
The method
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. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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
| 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
| Levered FCF (ā¹, Millions) | ā¹2.09b | ā¹2.30b | ā¹2.50b | ā¹2.71b | ā¹2.93b | ā¹3.15b | ā¹3.38b | ā¹3.63b | ā¹3.89b | ā¹4.17b |
| Growth Rate Estimate Source | Est @ 11.03% | Est @ 9.81% | Est @ 8.96% | Est @ 8.36% | Est @ 7.94% | Est @ 7.64% | Est @ 7.44% | Est @ 7.3% | Est @ 7.19% | Est @ 7.12% |
| Present Value (ā¹, Millions) Discounted @ 14% | ā¹1.8k | ā¹1.8k | ā¹1.7k | ā¹1.6k | ā¹1.5k | ā¹1.4k | ā¹1.4k | ā¹1.3k | ā¹1.2k | ā¹1.1k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ā¹15b
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 Ć (1 + g) Ć· (r ā g) = ā¹4.2bĆ (1 + 7.0%) Ć· (14%ā 7.0%) = ā¹63b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ā¹63bĆ· ( 1 + 14%)10= ā¹17b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ā¹32b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ā¹3.6k, the company appears about fair value at a 15% 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
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 HIL 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 0.830. 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:
Although the valuation of a company is important, 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. 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 HIL, there are three additional items you should explore:
- Risks: Case in point, we've spotted 3 warning signs for HIL you should be aware of.
- 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!
- Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!
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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Access Free AnalysisThis 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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About NSEI:HIL
HIL
Produces and distributes building materials and other solutions in India and internationally.
Established dividend payer and good value.
