Does the November share price of Torrent Pharmaceuticals Limited (NSE: TORNTPHARM) Does it reflect what it is really worth? Today, we will estimate the intrinsic value of the stock by estimating the company's future cash flows and discounting them at their present value. We will use the Discounted Cash Flow (DCF) model this time. Models like these may seem beyond a layman's comprehension, but they're pretty easy to follow.
We note that there are many ways to value a company and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you want more information about discounted cash flow, the justification for this calculation can be read in detail in the Simply Wall St Analysis Model.
See our latest Torrent Pharmaceuticals review
Pounding the numbers
We use what is known as a 2-stage model, which simply means that we have two different periods of growth rates for the company's cash flows. Generally, the first stage is a higher growth stage and the second stage is a lower growth stage. To start with, we need to get estimates of cash flows for the next ten years. When possible, we use analyst estimates, but when they are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with increasingly slow free cash flow will reduce their rate of contraction, and that companies with increasing free cash flow will see their growth rate slow down during this period. We do this to reflect that growth tends to slow more in the early years than in later years.
We generally assume that a dollar today is more valuable than a dollar in the future, so the sum of these future cash flows is discounted to the present value:
10-year free cash flow forecast (FCF)
| 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
| Leveraged FCF (โน, millions) | 19.3 billion rupees | 19.3 billion rupees | 21.9 billion | 24.2 billion rupees | 26.4 billion | 28.6 billion rupees | $ 30.9 billion | Rs 33.2 billion | 35.7 billion rupees | 38.2 billion rupees |
| Growth rate estimation source | Analyst x14 | Analyst x14 | Analyst x10 | Est @ 10.24% | Est @ 9.19% | Est @ 8.46% | Est @ 7.94% | Est @ 7.58% | Est @ 7.33% | Est @ 7.15% |
| Present value (โน, millions) discounted at 12% | $ 17.3 thousand | 15.5k | $ 15.7k | 15.5k | $ 15.2k | $ 14.7k | $ 14.2k | $ 13.7k | $ 13.2k | $ 12.6k |
("Est" = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = โน 148b
Now we need to calculate the terminal value, which represents 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 10-year government bond yield of 6.7%. We discount terminal cash flows to present value at 12% cost of capital.
Terminal value (TV)= FCF2031 ร (1 + g) รท (r - g) = โน 38b ร (1 + 6.7%) รท (12% - 6.7%) = โน 819b
Present value of terminal value (PVTV)= TV / (1 + r)10= โน 819b รท (1 + 12%)10= โน 270b
The total value is the sum of the cash flows of the next ten years plus the final discounted value, resulting in the Total Equity Value, which in this case is โน 418b. The last step is to divide the value of the share capital by the number of shares outstanding. Relative to the current share price of โน 2.8k, the company appears to be around fair value at the time of writing. However, the valuations are imprecise instruments, more like a telescope: they move a few degrees and end up in a different galaxy. Keep this in mind.
The assumptions
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. You do not have to agree with these entries, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the potential cyclicality of an industry or the future capital requirements of a company, so it does not provide a complete picture of a company's potential performance. Since we are considering Torrent Pharmaceuticals as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of equity (or weighted average cost of equity, WACC) that debt represents. In this calculation we have used 12%, which is based on a leveraged beta of 0.800. Beta is a measure of the volatility of a stock, compared to the market as a whole. We obtain our beta from the industry average beta of comparable companies worldwide, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
Forward:
While a business valuation is important, it shouldn't be the only metric to consider when researching a business. It is not possible to obtain a foolproof assessment with a DCF model. Preferably, you would apply different cases and assumptions and see how they would affect the valuation of the company. If a company grows at a different rate, or if its cost of capital or risk-free rate changes dramatically, production can look very different. For Torrent Pharmaceuticals, we have compiled three essential factors for you to consider:
- Risks: All companies have them and we have detected 2 Warning Signs for Torrent Pharmaceuticals must know.
- Future earnings: How does TORNTPHARM's growth rate compare to its peers and the wider market? Dig deeper into the number of analyst consensus for the next few years by interacting with our free analyst growth expectations chart.
- Other solid businesses: Low debt, high return on equity, and good past performance are critical to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies that you may not have considered.
P.S. Simply Wall St updates its DCF calculation for each Indian stock every day, so if you want to find the intrinsic value of any other stock, simply search here.
This Simply Wall St article is general in nature. We provide feedback based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares, and it does not take into account your objectives or your financial situation. Our goal is to provide you with long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative material. Simply Wall St has no position in any of the listed stocks.
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