An intrinsic calculation for UPL Limited (NSE: UPL) suggests it is 35% undervalued
Today we’re going to review one way to estimate the intrinsic value of UPL Limited (NSE: UPL) by taking the company’s future cash flow forecasts and discounting them to today’s value. hui. This will be done using the Discounted Cash Flow (DCF) model. There really isn’t much to it, although it might seem quite complex.
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
Check out our latest analysis for UPL
Step by step in the calculation
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) forecast
|Leverage FCF (₹, Millions)||₹ 51.5b||61.8b||₹ 70.5b||₹ 78.0b||₹ 85.4b||92.8b||₹ 100.3b||₹ 108.1b||116.1b||₹ 124.6b|
|Source of growth rate estimate||Analyst x16||Analyst x16||Analyst x5||Est @ 10.58%||East @ 9.46%||East @ 8.67%||Est @ 8.12%||Est @ 7.74%||Est @ 7.47%||East @ 7.28%|
|Present value (₹, millions) discounted at 15%||₹ 44.9k||47.0k||₹ 46.8k||45.1k||43.1k||40.8k||₹ 38.5k||₹ 36.2k||₹ 33.9k||₹ 31.7k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = ₹ 408b
Now we need to calculate the Terminal Value, which takes into account all future cash flows after this ten year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 6.8%. We discount terminal cash flows to their present value at a cost of equity of 15%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹ 125b × (1 + 6.8%) ÷ (15% – 6.8%) = ₹ 1.7t
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹ 1.7t ÷ (1 + 15%)ten= ₹ 434b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is ₹ 842b. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 719, the company appears to be quite undervalued with a 35% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider UPL 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 takes debt into account. In this calculation, we used 15%, which is based on a leveraged beta of 1.141. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
Valuation is only one side of the coin in terms of building your investment thesis, and ideally, it won’t be the only piece of analysis you look at for a business. The DCF model is not a perfect equity valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. What is the reason why the stock price is below intrinsic value? For UPL, we have compiled three additional aspects to consider:
- Risks: For example, we have identified 1 warning sign for UPL that you need to be aware of.
- Future benefits: How does UPL’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NSEI share. If you want to find the calculation for other actions, do a search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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