Key insights
- Based on the two-stage free cash flow to equity, the fair value estimate of the UPL is ₹704
- The current share price of ₹488 suggests that UPL is potentially 31% undervalued
- The analyst price target of ₹563 for UPL is 20% lower than our fair value estimate
Does UPL Limited’s (NSE:UPL) share price in April reflect what it is really worth? Today we estimate the stock’s intrinsic value by projecting its future cash flows and then discounting them to the current value. One way to achieve this is by using the Discounted Cash Flow (DCF) model. Models like these may seem beyond a layman’s understanding, but they are quite easy to follow.
We caution that there are many ways to value a company and that each technique, like the DCF, has advantages and disadvantages in certain scenarios. Anyone interested in learning more about intrinsic value should read the Simply Wall St analysis model.
Check out our latest analysis for UPL
What is the estimated valuation?
We are going to use a two-stage DCF model, which, as the name suggests, takes into account two stages of growth. The first phase is generally a period of higher growth, which levels off towards the terminal value captured in the second period of ‘steady growth’. To start, we need to get estimates of cash flows for the next ten years. Where possible we use analyst estimates, but if these are not available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to reflect that growth typically slows 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, and therefore the sum of these future cash flows is then discounted to today’s value:
Free cash flow (FCF) estimate over 10 years
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (₹, millions) | ₹37.5 billion | ₹53.4 billion | ₹61.2 billion | ₹67.8 billion | ₹74.2 billion | ₹80.7 billion | ₹87.2 billion | ₹93.9 billion | ₹100.9 billion | ₹108.1b |
Source of estimated growth rate | Analyst x8 | Analyst x12 | Analyst x10 | Estimated @ 10.79% | Estimated @ 9.56% | Estimated @ 8.71% | Estimated @ 8.11% | Estimated @ 7.69% | Estimated @ 7.39% | Estimated @ 7.19% |
Current Value (₹, millions) discounted @ 17% | ₹32.0k | ₹38.7k | ₹37.8k | ₹35.7k | ₹33.3k | ₹30.9k | ₹28.5k | ₹26.1k | ₹23.9k | ₹21.8k |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = ₹309 billion
The second phase is also called Terminal Value, which is the company’s cash flow after the first phase. 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 five-year average of the ten-year government bond yield (6.7%) to estimate future growth. In the same way as the 10-year ‘growth’ period, we discount future cash flows to present value, using a cost of equity of 17%.
Final value (TV)= FCF_{2033} × (1 + g) ÷ (r – g) = ₹108b× (1 + 6.7%) ÷ (17%– 6.7%) = ₹1.1t
Current Value of Final Value (PVTV)= TV / (1 + r)^{10}= ₹1.1t ÷ (1 + 17%)^{10}= ₹219 billion
The total value, or equity value, is then the sum of the present value of the future cash flows, in this case ₹528 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of ₹488, the company appears quite undervalued, at a 31% discount to the current share price. However, keep in mind that this is only an estimated valuation, and like any complex formula: garbage in, garbage out.
The assumptions
The above calculation is highly dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company’s future performance, so try the calculation yourself and check your own assumptions. The DCF also does not take into account the potential cyclicality of an industry, or a company’s future capital requirements, and thus does not provide 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 17%, which is based on a levered beta of 1.363. Beta is a measure of a stock’s volatility compared to the market as a whole. We take our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
SWOT analysis for UPL
- Dividend is among the top 25% of dividend payers in the market.
- Interest payments on debts are not properly covered.
- Expect to break even next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Good value based on P/S ratio and estimated fair value.
- Debts are not well covered by operating cash flow.
- Dividends are not covered by cash flow.
Next steps:
While a company’s valuation is important, ideally it won’t be the only piece of analysis you look at for a company. The DCF model is not a perfect tool for valuing shares. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would cause the company to be undervalued or overvalued. For example, if terminal value growth is adjusted slightly, it can dramatically change the overall result. What is the reason that the share price is below the intrinsic value? For UPL, we’ve put together three fundamental items you should investigate:
- Risks: Every company has them, and we’ve seen them 2 warning signs for UPL (1 of which relates to!) that you should be aware of.
- Future earnings: How does UPL’s growth rate compare to its peers and the broader market? Dive deeper into the analyst consensus figure for the coming years by using our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get an idea of what else you could be missing!
P.S. The Simply Wall St app performs a discounted cash flow valuation for each stock on the NSEI every day. If you want to find the calculation for other stocks, just search here.
Valuation is complex, but we help make it simple.
Invent or UPL may be over or undervalued if you look at our comprehensive analysis, including fair value estimates, risks and cautions, dividends, insider transactions and financial health.
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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. We aim to provide you with targeted, long-term analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Simply Wall St has no positions in the stocks mentioned.