Estimating The Fair Value Of Lloyds Steels Industries Limited (NSE:LSIL)

How far off is Lloyds Steels Industries Limited (NSE:LSIL) 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 their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Lloyds Steels Industries

What's the estimated valuation?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (₹, Millions)	₹67.5m	₹72.8m	₹78.4m	₹84.2m	₹90.3m	₹96.8m	₹103.7m	₹111.0m	₹118.8m	₹127.1m
Growth Rate Estimate Source	Est @ 8.28%	Est @ 7.89%	Est @ 7.61%	Est @ 7.41%	Est @ 7.28%	Est @ 7.18%	Est @ 7.12%	Est @ 7.07%	Est @ 7.04%	Est @ 7.01%
Present Value (₹, Millions) Discounted @ 16%	₹58.1	₹54.0	₹50.0	₹46.2	₹42.7	₹39.4	₹36.3	₹33.5	₹30.9	₹28.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹419m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 7.0%. We discount the terminal cash flows to today's value at a cost of equity of 16%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ₹127m× (1 + 7.0%) ÷ (16%– 7.0%) = ₹1.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹1.5b÷ ( 1 + 16%)¹⁰= ₹330m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹749m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₹0.9, 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

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 Lloyds Steels 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 16%, which is based on a levered beta of 1.087. 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.

Moving On:

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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Lloyds Steels Industries, there are three further items you should consider:

1. Risks: As an example, we've found 2 warning signs for Lloyds Steels Industries that you need to consider before investing here.
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. 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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