Stock Analysis

Estimating The Fair Value Of Torrent Power Limited (NSE:TORNTPOWER)

NSEI:TORNTPOWER
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Torrent Power Limited (NSE:TORNTPOWER) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Torrent Power

Step By Step Through The Calculation

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (₹, Millions) ₹9.66b ₹20.6b ₹20.9b ₹21.5b ₹22.4b ₹23.5b ₹24.8b ₹26.2b ₹27.8b ₹29.6b
Growth Rate Estimate Source Analyst x3 Analyst x3 Est @ 1.32% Est @ 2.96% Est @ 4.11% Est @ 4.91% Est @ 5.48% Est @ 5.87% Est @ 6.15% Est @ 6.34%
Present Value (₹, Millions) Discounted @ 14% ₹8.5k ₹16.0k ₹14.3k ₹12.9k ₹11.9k ₹11.0k ₹10.2k ₹9.5k ₹8.9k ₹8.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹111b

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) = ₹30b× (1 + 6.8%) ÷ (14%– 6.8%) = ₹469b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹469b÷ ( 1 + 14%)10= ₹132b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹243b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹529, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NSEI:TORNTPOWER Discounted Cash Flow December 10th 2022

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. 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 Torrent Power 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 Torrent Power

Strength
  • Debt is well covered by earnings and cashflows.
  • Dividend is in the top 25% of dividend payers in the market.
Weakness
  • Earnings declined over the past year.
  • 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.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 Torrent Power, we've compiled three additional elements you should further examine:

  1. Risks: For example, we've discovered 4 warning signs for Torrent Power that you should be aware of before investing here.
  2. Future Earnings: How does TORNTPOWER'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 Torrent Power 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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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.