Investors In Hexaware Technologies Limited (NSE:HEXAWARE) Are Paying Above The Intrinsic Value

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Hexaware Technologies Limited (NSEI:HEXAWARE) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not December 2017 then I highly recommend you check out the latest calculation for Hexaware Technologies by following the link below. See our latest analysis for Hexaware Technologies

Is HEXAWARE fairly valued?

I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. 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 the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

2017 2018 2019 2020 2021
Levered FCF (INR, Millions) ₹3,629.00 ₹3,993.00 ₹4,756.77 ₹5,461.87 ₹6,271.50
Source Analyst x8 Analyst x10 Analyst x10 Extrapolated @ (14.82%) Extrapolated @ (14.82%)
Present Value Discounted @ 13.4% ₹3,200.18 ₹3,105.08 ₹3,261.92 ₹3,302.85 ₹3,344.31

Present Value of 5-year Cash Flow (PVCF)= ₹16,214

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (7%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 13.4%.

Terminal Value (TV) = FCF2021 × (1 + g) ÷ (r – g) = ₹6,271 × (1 + 7%) ÷ (13.4% – 7%) = ₹104,852

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = ₹104,852 / ( 1 + 13.4%)5 = ₹55,913

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is ₹72,127. 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 of ₹243.01, which, compared to the current share price of ₹325.75, we see that Hexaware Technologies is quite expensive and not available at a discount at this time.

NSEI:HEXAWARE Intrinsic Value Dec 15th 17
NSEI:HEXAWARE Intrinsic Value Dec 15th 17

The assumptions

I’d like to 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Hexaware 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 13.4%, which is based on a levered beta of 0.8. 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. What is the reason for the share price to differ from the intrinsic value? For HEXAWARE, there are three important aspects you should further examine:

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.