Estimation of the intrinsic value of Sobha Limited (NSE: SOBHA)

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How far is Sobha Limited (NSE:SOBHA) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the company’s expected future cash flows and 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.

Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you want to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St Analysis Template.

See our latest analysis for Sobha

The model

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.

Generally, 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 present value:

10-Year Free Cash Flow (FCF) Forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF (₹, million) ₹7.02b ₹4.40b ₹4.64b ₹5.79b ₹5.65b ₹5.66b ₹5.79b ₹5.99b ₹6.26b ₹6.59b
Growth rate estimate Source Analyst x2 Analyst x2 Analyst x2 Analyst x1 Is @ -2.53% Is 0.25% Is at 2.19% Is at 3.56% Is at 4.51% Is at 5.17%
Present value (₹, million) discounted at 15% ₹6,100 ₹3,300 ₹3,100 ₹3,300 ₹2.8k ₹2.5k ₹2,200 ₹2,000 ₹1.8k ₹1,700

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) =₹29b

After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond 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 15%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹6.6b × (1 + 6.7%) ÷ (15%–6.7%) = ₹88b

Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹88b÷ ( 1 + 15%)ten=₹22b

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is ₹51 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹497, the company appears to be roughly fair value at a 7.4% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

NSEI: discounted cash flow SOBHA May 28, 2022

Important assumptions

We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree with these results, try the math yourself and play around with the 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 consider Sobha 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 15%, which is based on a leveraged beta of 1.250. 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.

Let’s move on :

Although important, the DCF calculation is just one of many factors you need to assess for a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or in the risk-free rate can have a significant impact on the valuation. For Sobha, we’ve compiled three more things you should dig into:

  1. Risks: Take risks, for example – Sobha a 3 warning signs (and 1 which is a little obnoxious) that we think you should know about.
  2. Future earnings: How does SOBHA’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.
  3. 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 for every Indian stock every day, so if you want to find the intrinsic value of any other stock, just search here.

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.

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