Stock Analysis

# Calculating The Fair Value Of PVR Limited (NSE:PVR)

Does the May share price for PVR Limited (NSE:PVR) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for PVR

### 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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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 (â‚¹, Millions) -â‚¹2.10b â‚¹5.93b â‚¹6.13b â‚¹11.9b â‚¹12.9b â‚¹13.8b â‚¹14.8b â‚¹15.8b â‚¹16.9b â‚¹18.0b Growth Rate Estimate Source Analyst x16 Analyst x16 Analyst x16 Analyst x1 Analyst x1 Est @ 7.09% Est @ 6.98% Est @ 6.9% Est @ 6.85% Est @ 6.82% Present Value (â‚¹, Millions) Discounted @ 14% -â‚¹1.8k â‚¹4.5k â‚¹4.1k â‚¹7.0k â‚¹6.6k â‚¹6.2k â‚¹5.8k â‚¹5.4k â‚¹5.0k â‚¹4.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = â‚¹47b

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 (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 Ã— (1 + g) Ã· (r â€“ g) = â‚¹18bÃ— (1 + 6.7%) Ã· (14%â€“ 6.7%) = â‚¹252b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= â‚¹252bÃ· ( 1 + 14%)10= â‚¹66b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is â‚¹113b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of â‚¹1.7k, the company appears about fair value at a 8.6% 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.

### Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 PVR 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 1.188. 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 is only one of many factors that you need to assess for 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. 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 PVR, there are three relevant factors you should explore:

1. Financial Health: Does PVR have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does PVR'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 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!

PS. Simply Wall St updates its DCF calculation for every Indian stock every day, so if you want to find the intrinsic value of any other stock just search here.

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