A Look At The Fair Value Of JK Paper Ltd (NSE:JKPAPER)

In this article we are going to estimate the intrinsic value of JK Paper Ltd (NSE:JKPAPER) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for JK Paper

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 start off with, we need to estimate 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, 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) forecast

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (₹, Millions)	₹1.90b	₹8.17b	₹9.55b	₹10.6b	₹11.7b	₹12.8b	₹13.8b	₹14.9b	₹16.0b	₹17.2b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 11.46%	Est @ 10.04%	Est @ 9.05%	Est @ 8.35%	Est @ 7.87%	Est @ 7.52%	Est @ 7.29%
Present Value (₹, Millions) Discounted @ 18%	₹1.6k	₹5.9k	₹5.8k	₹5.5k	₹5.1k	₹4.7k	₹4.4k	₹4.0k	₹3.6k	₹3.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹44b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (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 18%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = ₹17b× (1 + 6.7%) ÷ (18%– 6.7%) = ₹164b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹164b÷ ( 1 + 18%)¹⁰= ₹32b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹76b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹365, the company appears about fair value at a 18% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

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. 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 JK Paper 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 1.743. 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.

Next Steps:

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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For JK Paper, there are three additional factors you should explore:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with JK Paper (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.
2. Future Earnings: How does JKPAPER'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. 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.