Intrinsic Calculation For SRF Limited (NSE:SRF) Shows Investors Are Overpaying

Simply Wall St.

Sat, Oct 27, 2018, 7:15 PM

How far off is SRF Limited (NSE:SRF) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. This is done 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 October 2018 then I highly recommend you check out the latest calculation for SRF by following the link below.

Check out our latest analysis for SRF

What’s the value?

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 begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow estimate

	2019	2020	2021	2022	2023
Levered FCF (₹, Millions)	₹2.84k	₹3.85k	₹6.01k	₹6.47k	₹6.96k
Source	Analyst x4	Analyst x5	Analyst x2	Est @ 7.64%	Est @ 7.64%
Present Value Discounted @ 13.55%	₹2.50k	₹2.98k	₹4.11k	₹3.89k	₹3.69k

Present Value of 5-year Cash Flow (PVCF)= ₹17.2b

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 (7.7%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 13.5%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = ₹7.0b × (1 + 7.7%) ÷ (13.5% – 7.7%) = ₹129.0b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = ₹129.0b ÷ ( 1 + 13.5%)⁵ = ₹68.4b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is ₹85.5b. 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 ₹1486.18. Compared to the current share price of ₹1791.55, the stock is fair value, maybe slightly overvalued at the time of writing.

NSEI:SRF Intrinsic Value Export October 28th 18

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at SRF 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 13.5%, which is based on a levered beta of 0.800. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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 SRF, I’ve compiled three essential factors you should further examine:

Financial Health: Does SRF have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does SRF’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: Are there other high quality stocks you could be holding instead of SRF? 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 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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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