Calculating The Intrinsic Value Of GAIL (India) Limited (NSE:GAIL)

Key Insights

• The projected fair value for GAIL (India) is ₹175 based on 2 Stage Free Cash Flow to Equity
• With ₹170 share price, GAIL (India) appears to be trading close to its estimated fair value
• Our fair value estimate is 15% lower than GAIL (India)'s analyst price target of ₹206

How far off is GAIL (India) Limited (NSE:GAIL) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (₹, Millions)	₹48.3b	₹60.6b	₹70.7b	₹79.2b	₹87.4b	₹95.6b	₹103.8b	₹112.1b	₹120.7b	₹129.6b
Growth Rate Estimate Source	Analyst x7	Analyst x8	Analyst x6	Est @ 11.95%	Est @ 10.41%	Est @ 9.32%	Est @ 8.56%	Est @ 8.03%	Est @ 7.66%	Est @ 7.40%
Present Value (₹, Millions) Discounted @ 13%	₹42.8k	₹47.7k	₹49.3k	₹49.0k	₹48.0k	₹46.5k	₹44.8k	₹42.9k	₹41.0k	₹39.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹451b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 6.8%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = ₹130b× (1 + 6.8%) ÷ (13%– 6.8%) = ₹2.3t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹2.3t÷ ( 1 + 13%)¹⁰= ₹698b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹1.1t. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₹170, the company appears about fair value at a 2.5% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at GAIL (India) 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 accounts for debt. In this calculation we've used 13%, which is based on a levered beta of 0.800. Beta is a measure of a stock's volatility, compared 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.

View our latest analysis for GAIL (India)

SWOT Analysis for GAIL (India)

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For GAIL (India), we've put together three additional aspects you should explore:

1. Risks: For instance, we've identified 2 warning signs for GAIL (India) that you should be aware of.
2. Future Earnings: How does GAIL's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.