In this article, we will estimate the intrinsic value of Tata Teleservices (Maharashtra) Limited (NSE: TTML) by estimating the company’s future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Don’t be put off by the lingo, the underlying calculations are actually pretty straightforward.
There are many ways that businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
Check out our latest review for Tata Teleservices (Maharashtra)
What is the estimated valuation?
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth, and the second stage is lower growth stage. First, we need to estimate the cash flow of the business over the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. 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.
In general, we assume that a dollar today is worth more than a dollar in the future, 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)||₹ 7.06b||₹ 11.3b||16.4b||₹ 21.9b||27.4b||₹ 32.8b||₹ 38.0b||₹ 43.0b||₹ 47.8b||₹ 52.5b|
|Source of estimated growth rate||East @ 84.03%||Is 60.85%||Is 44.61%||Est @ 33.25%||Is 25.3%||Est @ 19.73%||Est @ 15.83%||Est @ 13.11%||East @ 11.2%||East @ 9.86%|
|Present value (₹, millions) discounted at 12%||6.3k||9.1k||11.8k||₹ 14.0k||15.7k||16.9k||17.5k||₹ 17.7k||17.6k||17.3k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 144b
The second stage is also known as terminal value, it is the cash flow of the business 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 used the 5-year average of the 10-year government bond yield (6.7%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 12%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹ 53b × (1 + 6.7%) ÷ (12% – 6.7%) = ₹ 1.1t
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹ 1.1t ÷ (1 + 12%)ten= 371b
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 515. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of 217, the company is shown at fair value at a discount of 18% from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
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 full picture of a company’s potential performance. Since we view Tata Teleservices (Maharashtra) as a potential shareholder, 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 12%, which is based on a leverage beta of 0.800. 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 an imposed limit 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 stock assessment tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Tata Teleservices (Maharashtra), we have compiled three fundamental aspects that you should explore:
- Risks: To this end, you should inquire about the 2 warning signs we spotted with Tata Teleservices (Maharashtra) (including 1 which does not suit us too much).
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
- Other picks from top analysts: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!
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.
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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 any stock 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 any of the stocks mentioned.