Stock Analysis

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

How far off is PVR Limited (NSE:PVR) 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. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 PVR

## Is PVR Fairly Valued?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 discount the value of these future cash flows to their estimated value in today's dollars:

#### 10-year free cash flow (FCF) estimate

 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (₹, Millions) ₹6.13b ₹8.61b ₹11.0b ₹13.7b ₹15.9b ₹18.0b ₹20.1b ₹22.1b ₹24.1b ₹26.1b Growth Rate Estimate Source Analyst x9 Analyst x10 Analyst x7 Analyst x1 Est @ 16.27% Est @ 13.43% Est @ 11.44% Est @ 10.04% Est @ 9.07% Est @ 8.38% Present Value (₹, Millions) Discounted @ 17% ₹5.2k ₹6.3k ₹6.8k ₹7.3k ₹7.2k ₹7.0k ₹6.7k ₹6.3k ₹5.8k ₹5.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹64b

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 (6.8%) 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 17%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = ₹26b× (1 + 6.8%) ÷ (17%– 6.8%) = ₹271b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹271b÷ ( 1 + 17%)10= ₹56b

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 ₹120b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₹1.8k, the company appears about fair value at a 11% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

## 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. 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 17%, which is based on a levered beta of 1.132. 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.

### SWOT Analysis for PVR

Strength
• Debt is well covered by cash flow.
Weakness
• Interest payments on debt are not well covered.
Opportunity
• Expected to breakeven next year.
• Has sufficient cash runway for more than 3 years based on current free cash flows.
• Good value based on P/S ratio and estimated fair value.
Threat
• No apparent threats visible for PVR.

## Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize 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, we've put together three important elements 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. 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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