The intrinsic value of National Aluminium Company Limited (NSE:NATIONALUM) may be 35% above its share price

Key findings

• Using 2-step free cash flow to equity, the fair value of National Aluminium is ₹259
• The current share price of Rs 191 suggests that National Aluminium may be undervalued by 26%
• The analyst price target of ₹178 for NATIONALUM is 31% below our fair value estimate

Today we’ll walk through one way to estimate the intrinsic value of National Aluminium Company Limited (NSE:NATIONALUM) by taking the 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 can’t understand it, just keep reading! It’s actually a lot less complex than you think.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one method. If you still have pressing questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for National Aluminium

Step by step through the calculation

We use the 2-stage growth model, which simply means that we consider two stages of company growth. In the early stage, the company might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to estimate the next ten years’ cash flows. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that 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 take into account that growth tends to slow down more in the early years than in later years.

A DCF is all about the idea that a dollar in the future is worth less than a dollar today. So we discount the value of these future cash flows to their estimated value in today’s dollars:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = ₹190 billion

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon 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 Treasury yield of 6.7%. We discount the terminal cash flows to today’s value using a cost of equity of 15%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₹97b × (1 + 6.7%) ÷ (15% – 6.7%) = ₹1.2t

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 1.2 t ₹ ÷ (1 + 15 %)¹⁰= ₹285 billion

The total value or equity value is then the sum of the present value of future cash flows, which in this case is Rs 475 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of Rs 191, the company appears slightly undervalued at a discount of 26% to the current share price. However, keep in mind that this is only an approximate valuation and as with any complex formula, where there is garbage in, there is garbage out.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these inputs, I recommend repeating the calculations yourself and playing around with them. The DCF also doesn’t take into account the potential cyclicality of an industry or a company’s future capital needs, so it doesn’t give a complete picture of a company’s potential performance. Since we consider National Aluminum 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 1.110. Beta is a measure of a stock’s volatility relative to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for National Aluminium

Looking ahead:

Valuation is only one side of the coin when building your investment thesis and ideally shouldn’t be the only analysis you look at for a company. The DCF model is not a perfect stock valuation tool. It should be viewed more as a guide to “what assumptions need to be true for this stock to be under/overvalued.” For example, slightly adjusting the terminal value growth rate can dramatically change the overall outcome. Why is the intrinsic value higher than the current share price? There are three key points to consider with National Aluminum:

1. Risks: We think you should 2 warning signs for National Aluminium We indicated this before investing in the company.
2. Future income: How is NATIONALUM’s growth rate compared to competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business 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 daily, so if you want to find out the intrinsic value of any other stock, just search here.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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