In this article, we will estimate the intrinsic value of JSW Steel Limited (NSE:JSWSTEEL) by taking expected future cash flows and discounting them to their present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. This may sound complicated, but it’s actually quite simple!

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 flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.

See our latest review for JSW Steel

What is the estimated valuation?

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, and so the sum of these future cash flows is then discounted to today’s value:

Estimated free cash flow (FCF) over 10 years

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = ₹738b

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) = ₹291b × (1 + 6.7%) ÷ (15%–6.7%) = ₹3.8t

Present value of terminal value (PVTV)= TV / (1 + r)^ten= ₹3.8t÷ ( 1 + 15%)^ten=₹931b

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is ₹1.7t. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of ₹563, the company appears to be roughly fair value at a 19% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.

The hypotheses

We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 JSW Steel 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 15%, which is based on a leveraged beta of 1.286. 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 :

While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. DCF models are not the be-all and end-all of investment valuation. 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 the risk-free rate can have a significant impact on the valuation. For JSW Steel, there are three relevant elements you need to evaluate:

1. Risks: For example, we discovered 4 warning signs for JSW Steel (1 cannot be ignored!) which you should be aware of before investing here.
2. Future earnings: How does JSWSTEEL’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 high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

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.