Estimating The Fair Value Of J. B. Chemicals & Pharmaceuticals Limited (NSE:JBCHEPHARM)

Today we will run through one way of estimating the intrinsic value of J. B. Chemicals & Pharmaceuticals Limited (NSE:JBCHEPHARM) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for J. B. Chemicals & Pharmaceuticals

The calculation

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.

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) estimate

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (₹, Millions)	₹647.0m	₹3.04b	₹4.82b	₹6.33b	₹7.56b	₹8.74b	₹9.88b	₹11.0b	₹12.0b	₹13.1b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x4	Analyst x1	Est @ 19.45%	Est @ 15.63%	Est @ 12.96%	Est @ 11.09%	Est @ 9.78%	Est @ 8.87%
Present Value (₹, Millions) Discounted @ 12%	₹578	₹2.4k	₹3.4k	₹4.0k	₹4.3k	₹4.5k	₹4.5k	₹4.5k	₹4.4k	₹4.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹37b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 6.7%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = ₹13b× (1 + 6.7%) ÷ (12%– 6.7%) = ₹273b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹273b÷ ( 1 + 12%)¹⁰= ₹89b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹126b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of ₹1.5k, the company appears about fair value at a 7.0% 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

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 J. B. Chemicals & Pharmaceuticals 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 12%, which is based on a levered beta of 0.800. 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.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 J. B. Chemicals & Pharmaceuticals, we've compiled three fundamental items you should further examine:

1. Risks: As an example, we've found 2 warning signs for J. B. Chemicals & Pharmaceuticals (1 is a bit unpleasant!) that you need to consider before investing here.
2. Future Earnings: How does JBCHEPHARM'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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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.