A look at the fair value of INOX Leisure Limited (NSE: INOXLEISUR)
Today we are going to give a simple overview of a valuation method used to estimate the attractiveness of INOX Leisure Limited (NSE: INOXLEISUR) as an investment opportunity by projecting its cash flows future, then discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Discover our latest analysis for INOX Loisirs
We use what is called a 2-step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (₹, million)||-₹324.8 million||₹3.21 billion||₹3.60b||₹6.53b||₹6.84 billion||₹7.17 billion||₹7.57 billion||₹8.01b||₹8.50b||₹9.04 billion|
|Growth rate estimate Source||Analyst x10||Analyst x10||Analyst x9||Analyst x1||Analyst x1||Is at 4.94%||Is at 5.48%||Is at 5.86%||Is at 6.12%||Is at 6.31%|
|Present value (₹, million) discounted at 14%||-285₹||₹2.5k||₹2,400||₹3,900||₹3.5k||₹3,300||₹3,000||₹2.8k||₹2.6k||₹2,400|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) =₹26b
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 6.7%. We discount terminal cash flows to present value at a cost of equity of 14%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹9.0b × (1 + 6.7%) ÷ (14%–6.7%) = ₹132b
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹132b÷ ( 1 + 14%)ten=₹36b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is ₹62 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹433, the company appears to be roughly fair value at a 14% discount to the current share price. Remember though 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 flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 INOX Leisure 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 14%, which is based on a leveraged beta of 1.170. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Although the valuation of a business is important, it will ideally not be the only piece of analysis you will look at for a business. The DCF model is not a perfect stock valuation tool. Instead, the best use of 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, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For INOX Loisirs, there are three relevant elements to assess:
- Risks: Know that INOX Loisirs presents 1 warning sign in our investment analysis , you should know…
- Future earnings: How does INOXLEISUR’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation daily for every Indian stock, so if you want to find the intrinsic value of any other stock, just 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 only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.