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 five years of cash flows. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
| 2018 | 2019 | 2020 | 2021 | 2022 | |
| Levered FCF ($, Millions) | $652.44 | $1.18k | $1.33k | $1.46k | $1.61k |
| Source | Analyst x19 | Analyst x21 | Analyst x22 | Analyst x11 | Extrapolated @ (10.11%) |
| Present Value Discounted @ 13.55% | $574.60 | $913.00 | $906.69 | $878.06 | $851.45 |
Present Value of 5-year Cash Flow (PVCF)= US$4.12b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 7.7%. We discount this to today’s value at a cost of equity of 13.5%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$1.61b × (1 + 7.7%) ÷ (13.5% – 7.7%) = US$29.77b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$29.77b ÷ ( 1 + 13.5%)5 = US$15.77b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$19.90b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value in the company’s reported currency of $14.29. However, HCLTECH’s primary listing is in India, and 1 share of HCLTECH in USD represents 68.795 ( USD/ INR) share of BSE:532281, so the intrinsic value per share in INR is ₹982.97. Relative to the current share price of ₹921.05, the stock is about right, perhaps slightly undervalued at a 6.30% discount to what it is available for right now.
Important assumptions
Now 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at HCL Technologies as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 13.5%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on 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, DCF calculation shouldn’t be the only metric you look at when researching a company. For HCLTECH, I’ve put together three key factors you should further research:
- Financial Health: Does HCLTECH 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.
- Future Earnings: How does HCLTECH’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of HCLTECH? 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 does a DCF calculation for every IN stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.