Lloyds Steels Industries Limited (NSE: LSIL) Fair Value Estimate

How far is Lloyds Steels Industries Limited (NSE: LSIL) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking expected future cash flows and discounting them to their present value. Our analysis will use the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.

We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without flaws. For those who are learning equity analysis thoroughly, the Simply Wall St Analysis Template here may be of interest to you.

Check out our latest review for Lloyds Steels Industries

What is the estimated valuation?

We are going to use a two-step DCF model which, as the name suggests, takes into account two growth stages. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to get cash flow estimates for the next ten years. Since no analysts estimate of free cash flow is available to us, we have extrapolated past free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow down their withdrawal rate and companies with increasing free cash flow will see their growth rate slow down during this time period. We do this to reflect that growth tends to slow down more in the early years than in the following years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of these future cash flows is then discounted to present value:

10-year Free Cash Flow (FCF) forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = ₹ 419m

The second stage is also known as terminal value, it is the cash flow of the business after the first stage. Gordon’s growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 7.0%. We discount terminal cash flows to present value at a cost of equity of 16%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ₹ 127m × (1 + 7.0%) ÷ (16% – 7.0%) = ₹ 1.5 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= 1.5 billion ₹ ÷ (1 + 16%)^ten= ₹ 330 million

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is ₹ 749 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹ 0.9, the company appears to be around fair value at the time of writing. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.

Important assumptions

We draw your attention to the fact that the most important data for a discounted cash flow is the discount rate and of course the actual cash flow. Part of investing is making 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 Lloyds Steels Industries 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 into account debt. In this calculation, we used 16%, which is based on a leveraged beta of 1.087. 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 of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Move on:

While valuing a business is important, it is just one of the many factors you need to assess for a business. The DCF model is not a perfect equity valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Lloyds Steels Industries, there are three other things to consider:

1. Risks: As an example, we found 2 warning signs for Lloyds Steels Industries that you need to consider before investing here.
2. 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 solid trading fundamentals to see if there are other companies you may not have considered!
3. Other environmentally friendly companies: Concerned about the environment and think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies envisioning a greener future to discover actions you might not have thought of!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NSEI share. If you want to find the calculation for other actions, just search here.

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This Simply Wall St article is general in nature. It is not a recommendation to buy or sell stocks, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in the mentioned stocks.
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