Calculating The Intrinsic Value Of Sun Pharmaceutical Industries Limited (NSE:SUNPHARMA)

By
Simply Wall St
Published
September 27, 2021
NSEI:SUNPHARMA
Source: Shutterstock

Today we will run through one way of estimating the intrinsic value of Sun Pharmaceutical Industries Limited (NSE:SUNPHARMA) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

Check out our latest analysis for Sun Pharmaceutical Industries

Crunching the numbers

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (₹, Millions) ₹41.2b ₹66.4b ₹84.8b ₹99.8b ₹114.2b ₹128.1b ₹141.6b ₹155.0b ₹168.4b ₹182.1b
Growth Rate Estimate Source Analyst x14 Analyst x14 Analyst x7 Est @ 17.69% Est @ 14.44% Est @ 12.16% Est @ 10.56% Est @ 9.45% Est @ 8.66% Est @ 8.12%
Present Value (₹, Millions) Discounted @ 12% ₹36.7k ₹52.6k ₹59.8k ₹62.7k ₹63.9k ₹63.8k ₹62.8k ₹61.2k ₹59.2k ₹57.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹580b

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 6.8%. 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) = ₹182b× (1 + 6.8%) ÷ (12%– 6.8%) = ₹3.6t

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹3.6t÷ ( 1 + 12%)10= ₹1.1t

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹1.7t. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹763, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NSEI:SUNPHARMA Discounted Cash Flow September 28th 2021

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Sun Pharmaceutical 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 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.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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 Sun Pharmaceutical Industries, there are three additional elements you should look at:

  1. Risks: You should be aware of the 1 warning sign for Sun Pharmaceutical Industries we've uncovered before considering an investment in the company.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SUNPHARMA's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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.

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.

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