Stock Analysis

Estimating The Fair Value Of JSW Energy Limited (NSE:JSWENERGY)

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NSEI:JSWENERGY
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How far off is JSW Energy Limited (NSE:JSWENERGY) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out the opportunities and risks within the IN Renewable Energy industry.

What's The Estimated Valuation?

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 start off with, we need to estimate 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.

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) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (₹, Millions) ₹14.7b ₹38.3b ₹39.6b ₹41.2b ₹43.2b ₹45.6b ₹48.3b ₹51.2b ₹54.5b ₹58.0b
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Est @ 4.1% Est @ 4.9% Est @ 5.47% Est @ 5.87% Est @ 6.14% Est @ 6.34% Est @ 6.47%
Present Value (₹, Millions) Discounted @ 14% ₹13.0k ₹29.7k ₹27.1k ₹24.8k ₹22.9k ₹21.3k ₹19.9k ₹18.6k ₹17.4k ₹16.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹211b

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 14%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = ₹58b× (1 + 6.8%) ÷ (14%– 6.8%) = ₹920b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹920b÷ ( 1 + 14%)10= ₹259b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is ₹470b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₹304, 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:JSWENERGY Discounted Cash Flow December 8th 2022

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 JSW Energy 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 14%, 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 JSW Energy

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Renewable Energy market.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
Threat
  • Paying a dividend but company has no free cash flows.
  • Annual earnings are forecast to grow slower than the Indian market.

Next Steps:

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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For JSW Energy, we've compiled three pertinent items you should look at:

  1. Risks: Every company has them, and we've spotted 2 warning signs for JSW Energy you should know about.
  2. Future Earnings: How does JSWENERGY'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

Valuation is complex, but we're helping make it simple.

Find out whether JSW Energy is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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