The share price of Barbeque Nation Hospitality Ltd. (NSE: BARBECUE) in January reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to their present value. This will be done using the discounted cash flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.
See our latest review for Barbeque Nation Hospitality
Step by step in the calculation
We will use a two-stage 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 “sustained growth”. To begin with, we need to obtain cash flow estimates for 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.
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 present value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF (₹, million)||₹ -369.7 million||₹39.3 million||₹860.5 million||₹1.61 billion||₹2.64 billion||₹3.86 billion||₹5.18b||₹6.54 billion||₹7.87 billion||₹9.15 billion|
|Growth rate estimate Source||Analyst x4||Analyst x3||Analyst x4||Is at 87.53%||Is at 63.29%||Is at 46.33%||Is at 34.45%||Is at 26.14%||Is at 20.32%||Is at 16.25%|
|Present value (₹, million) discounted at 14%||-325₹||₹30.3||₹583||₹960||₹1.4k||₹1.8k||₹2,100||₹2,300||₹2,400||₹2.5k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = ₹14b
The second stage is also known as the 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 which 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 present value, using a cost of equity of 14%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹9.1b × (1 + 6.7%) ÷ (14%–6.7%) = ₹137b
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹137b÷ ( 1 + 14%)ten=₹38b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹51 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Against the current share price of ₹1.5k, the company appears around fair value at the time of writing. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. 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 view Barbeque Nation Hospitality 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 factors in debt. In this calculation, we used 14%, which is based on a leveraged beta of 1.141. 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.
While important, calculating DCF shouldn’t be the only metric to consider when researching a business. The DCF model is not a perfect stock 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 company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Barbeque Nation Hospitality, we have compiled three relevant factors you should assess:
- Risks: We believe that you should evaluate the 2 warning signs for Barbeque Nation Hospitality we reported before investing in the company.
- Management:Did insiders increase their shares to take advantage of market sentiment about the future prospects of BARBECUE? View our management and board analysis with insights into CEO compensation and governance factors.
- 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. The Simply Wall St app performs an updated cash flow valuation for each NSEI stock each day. If you want to find the calculation for other stocks, 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.