Estimating The Intrinsic Value Of Prakash Industries Limited (NSE:PRAKASH)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Prakash Industries fair value estimate is ₹193
• With ₹193 share price, Prakash Industries appears to be trading close to its estimated fair value
• Prakash Industries' peers seem to be trading at a higher premium to fair value based onthe industry average of -360%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Prakash Industries Limited (NSE:PRAKASH) as an investment opportunity 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

See our latest analysis for Prakash Industries

Is Prakash Industries Fairly Valued?

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₹, Millions)	₹3.15b	₹3.40b	₹3.67b	₹3.94b	₹4.22b	₹4.52b	₹4.83b	₹5.17b	₹5.52b	₹5.90b
Growth Rate Estimate Source	Est @ 8.70%	Est @ 8.11%	Est @ 7.69%	Est @ 7.40%	Est @ 7.20%	Est @ 7.06%	Est @ 6.96%	Est @ 6.89%	Est @ 6.84%	Est @ 6.81%
Present Value (₹, Millions) Discounted @ 16%	₹2.7k	₹2.5k	₹2.3k	₹2.2k	₹2.0k	₹1.8k	₹1.7k	₹1.6k	₹1.4k	₹1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹20b

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 16%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₹5.9b× (1 + 6.7%) ÷ (16%– 6.7%) = ₹67b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹67b÷ ( 1 + 16%)¹⁰= ₹15b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹35b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ₹193, 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. 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 Prakash 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 1.130. 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:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 Prakash Industries, we've compiled three important aspects you should explore:

1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Prakash Industries (including 1 which is potentially serious) .
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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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.