Calculating The Fair Value Of MSTC Limited (NSE:MSTC)
Simply Wall St
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Today we will run through one way of estimating the intrinsic value of MSTC Limited (NSE:MSTC) by taking the expected future cash flows and discounting them to their present value. This is done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
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 begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
Levered FCF (₹, Millions)
₹844.53
₹927.25
₹1.01k
₹1.10k
₹1.19k
₹1.29k
₹1.39k
₹1.50k
₹1.61k
₹1.74k
Growth Rate Estimate Source
Est @ 10.76%
Est @ 9.79%
Est @ 9.12%
Est @ 8.65%
Est @ 8.32%
Est @ 8.09%
Est @ 7.93%
Est @ 7.81%
Est @ 7.73%
Est @ 7.68%
Present Value (₹, Millions) Discounted @ 19.28%
₹708.05
₹651.76
₹596.26
₹543.14
₹493.24
₹446.98
₹404.45
₹365.58
₹330.20
₹298.10
Present Value of 10-year Cash Flow (PVCF)= ₹4.84b
"Est" = FCF growth rate estimated by Simply Wall St
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 10-year government bond rate (7.6%) 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 19.3%.
Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = ₹₹16b ÷ ( 1 + 19.3%)10 = ₹2.73b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹7.57b. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of ₹107.55. Relative to the current share price of ₹86.6, the company appears about fair value at a 19% discount to where the stock price trades currently. 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.
NSEI:MSTC Intrinsic value, June 28th 2019
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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 MSTC 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 19.3%, which is based on a levered beta of 1.364. 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.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For MSTC, I've put together three essential factors you should look at:
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of MSTC? 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 updates its DCF calculation for every IN stock every day, so if you want to find the intrinsic value of any other stock just search here.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
