EQUITY RESEARCH OF ALOK INDUSTRIES LIMITED VALUATION MODEL
FREE CASH FLOW TO EQUITY (FCFE): Free cash flow to equity model is one of
method of Equity Discounted Cash Flow. In this method we discount potential dividends rather then actual dividends. In this method dividend calculated is different from what company actual give dividend due to various reason: Desire for Stability Future Investment Tax Factors Here, value of equity can be calculated as follows:
VALUE OF EQUITY =
Where: FCFE=Free cash Flow to Equity K= Cost of Equity
VALUE OF PER SHARE=
INPUTS TO THE FCFE MODEL ARE:
COST OF EQUITY: The cost of equity for a financial service firm has to reflect the portion of the risk in the equity that cannot be diversified away by the marginal investor in the stock. This risk is estimated using a beta (in the capital asset pricing model). The cost of equity can be found out by using regression betas if the regulatory restrictions have remained unchanged over the period .Formula to calculate Cost of equity :
COST OF EQUITY=Rf+B*(Rm-Rf) Where, Rf=Risk Free Return B= Beta Rm=Market return
FREE CASH FLOW TO EQUITY: This is a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment. In growing company free cash flow to equity is less because huge amount of money is invested in the form of CAPEX so the dividend calculated would be less. The formula to calculate free cash flow to equity is:
FREE CASH FLOW TO EQUITY=EBIT*(1-t) +D-Capex This will be clearer with the diagram
Note the followings Beta is calculated according to CAPM model. The market risk premium is assumed to be 7.19 % as the GDP of Indian economy is expected to grow at around 8-9% in the coming years. Risk free return is taken as 7.81% which is current T-Bill of 361 days. We have considered Capex as net block of assets. CALCULATION OF FCFE & SHARE PRICE OF ALOK INDUSTRY: YEAR 2012 2883.68 FCFE PRESENT VALUE OF EQUITY 2423.26 30.76 PRESENT SHARE PRICE 36.61 FUTURE SHARE PRICE (For calculation Please refer appendix) 2013 2819.82 2369.60 30.08 35.80 2014 3734.96 3138.62 39.85 47.42 2015 3893.17 3271.57 41.53 49.42
Analysis: As we see that FCFE is continues increasing year by year accept 2013 because working capital gap is high in that year. The reason behind increasing FCFE is that the company is almost finished with Capex and they dont have Capex investment plan for next few year. So by looking into this we can say that investor can expect higher return in near future.
Dividend Discount Model: Dividend Discount Model is a method which helps in determing
the value of the company. In this method net income is taken into consideration and this method is apt as it tells the present and future value of the firm. The method also tells whether the value of firm being over-valued or under-valued. The firm value is over valued when the market price of the share is being more than computed value and vice-versa. Here, the value of equity per share can be calculated as follows:
Where, = Expected dividend per share in period t = Cost of equity
Value per Share =
So this was the basic formula of dividend discount model but there are various other model such as stable growth rate dividend discount model, Two-Stage dividend discount model and Three stage dividend discount model. Over here in this research we will use Gordon Growth Model because firm is maintaining stable growth rate. Gordon Growth Model: The model is a variant of Dividend Discount Model and it is basically used for valuing a stock or business. It is basically used to find the explicit market value of stock and business. It assumes that the company issues a dividend that has a current value of Dividend that grows at a constant rate growth. It also assumes that the required rate of return for the stock remains constant at k>g which is equal to the cost of equity for that company. Here, the value of equity per share can be calculated as follows:
Where,
= Value of stock = Expected dividend next year
= Cost of equity INPUT TO GORDON MODEL: COST OF EQUITY: The cost of equity for a financial service firm has to reflect the portion of the risk in the equity that cannot be diversified away by the marginal investor in the stock. This risk is estimated using a beta (in the capital asset pricing model). The cost of equity can be found out by using regression betas if the regulatory restrictions have remained unchanged over the period .Formula to calculate Cost of equity :
COST OF EQUITY=Rf+B*(Rm-Rf) Where, Rf=Risk Free Return B= Beta Rm=Market return
PAYOUT RATIOS: The expected dividend per share in a future period can be written as the product of the expected earnings per share in that period and the expected payout ratio EXPECTED GROWTH: If dividends are based upon earnings, the expected growth rate that will determine value is the expected growth rate in earnings.
Note the following: We have expected that dividend will grow at constant rate. Beta is calculated according to CAPM model. The market risk premium is assumed to be 7.19 % as the GDP of Indian economy is expected to grow at around 8-9% in the coming years. Risk free return is taken as 7.81% which is current T-Bill of 361 days. CALCULATION OF SHARE PRICE ACCORDING TO GORDON GROWTH MODEL YEAR 2012 DPS 7.09 VALUE OF 12.64 STOCK (For calculation please refer appendix) 2013 9.26 16.51 2014 12.41 22.13 2015 13.66 24.36
ANALYSIS: In this model we can see that share price is 12.64, 16.51 and so forth for different year and we can also see that share price is very low comparing to other model this is because company has potential to give better dividend but they are not giving because company is in growing stage and require huge amount of cash. So their dividend payout ratio is very low but it is clear that company has good future because dividend is growing every year.
MULTIPLE VALUATION MODEL: It is one of the quickest way to value a company. In this method we try to capture many of firms operating and financial characteristics (i.e. expected growth) in a single number that can be multiplied by some financial metric (e.g. EBITDA) to yield an enterprise or equity value. So for research purpose I have taken two such multiple which are EV/EBITDA and P/E ratio. P/E Ratio= P/E is one of the most commonly used valuation metrics, where the numerator is the price of the stock and the denominator is EPS. It is used to measure the price paid for a share relative to the annual net income or profit earned by the firm per share. This can be used to forecast the future share price of the company. P/E can be calculated: P/E Ratio= Where: EPS=Earning Per Share MPS= Market Price of Share Input to P/E ratio: EPS=Its earning per share which can be calculated by dividing PAT by no of share. MPS= Its the current market price of share which are trading in stock exchange.
CALCULATION OF SHARE PRICE ACCORDING TO P/E RATIO: YEAR EPS PRICE OF SHARE(MPS) P/E RATIO 2012
7.09
2013
9.26
2014
12.41
2015
13.66
29
4.09
29
3.13
29
2.34
29
2.12
Analysis: From this multiple of P/E ratio we can see that P/E ratio went down from 4.09 to
2.12 from FY12 to FY15 respectively. So we can say that earning per share is increasing so final consumer will get benefited in longer year. We can also calculate the expected market price of share 2015 by taking Average P/E ratio of 2.92 xs. So by this we can say that investor can expect 2.92 times more share price in 2015.
OVER ALL VALUATION: As we have used three methods to calculate share price of Alok Industry so come at one single price. So we have taken weight age of all the method. In which P/E ratio has been given much weight age of 70% followed by FCFE method with 20% weight age and least weight has been given to Gordon Model because since company do have potential to give dividend but they are not giving. So we can see the calculated share price here under:
PARTICULARS GORDON MODEL FCFE MODEL P/E RATIO MODEL
WEIGHT 10% 20% 70%
SHARE PRICE 24.36 49.42 84.69
WEIGHTAGE SHARE PRICE 2.44 9.88 59.28
Analysis: So from this we can say that there is more change that share price will be around
71.61 rs in 2015 which have present value of 35.71 which is more then what invested today so people should buy share.
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