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Calculating The Fair Value Of Tata Communications Limited (NSE:TATACOMM)
Key Insights
- Tata Communications' estimated fair value is ₹1,037 based on 2 Stage Free Cash Flow to Equity
- Current share price of ₹1,205 suggests Tata Communications is potentially trading close to its fair value
- Our fair value estimate is 31% higher than Tata Communications' analyst price target of ₹1,362
Does the February share price for Tata Communications Limited (NSE:TATACOMM) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for Tata Communications
The Method
We're 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 a stable growth rate. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF (₹, Millions) | ₹16.9b | ₹16.9b | ₹21.4b | ₹25.1b | ₹28.7b | ₹32.1b | ₹35.5b | ₹38.8b | ₹42.1b | ₹45.5b |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Analyst x3 | Est @ 17.35% | Est @ 14.19% | Est @ 11.97% | Est @ 10.42% | Est @ 9.34% | Est @ 8.58% | Est @ 8.05% |
Present Value (₹, Millions) Discounted @ 15% | ₹14.8k | ₹12.8k | ₹14.2k | ₹14.6k | ₹14.5k | ₹14.2k | ₹13.7k | ₹13.0k | ₹12.4k | ₹11.6k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹136b
The second stage is also known as Terminal Value, this is the business's cash flow after 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 15%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = ₹45b× (1 + 6.8%) ÷ (15%– 6.8%) = ₹624b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹624b÷ ( 1 + 15%)10= ₹160b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹296b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ₹1.2k, the company appears around fair value at the time of writing. 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.
The 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 Tata Communications 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 15%, 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.
SWOT Analysis for Tata Communications
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings and cashflows.
- Dividends are covered by earnings and cash flows.
- Dividend is in the top 25% of dividend payers in the market.
- Earnings growth over the past year is below its 5-year average.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio compared to estimated Fair P/E ratio.
- Annual earnings are forecast to grow slower than the Indian market.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Tata Communications, there are three important elements you should further examine:
- Risks: For example, we've discovered 2 warning signs for Tata Communications that you should be aware of before investing here.
- Future Earnings: How does TATACOMM'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: 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.
Valuation is complex, but we're here to simplify it.
Discover if Tata Communications might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
About NSEI:TATACOMM
Reasonable growth potential average dividend payer.