Calculating The Intrinsic Value Of Solara Active Pharma Sciences Limited (NSE:SOLARA)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Solara Active Pharma Sciences fair value estimate is ₹722
• Current share price of ₹606 suggests Solara Active Pharma Sciences is potentially trading close to its fair value
• Solara Active Pharma Sciences' peers are currently trading at a premium of 496% on average

In this article we are going to estimate the intrinsic value of Solara Active Pharma Sciences Limited (NSE:SOLARA) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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)	₹1.60b	₹1.88b	₹2.14b	₹2.39b	₹2.64b	₹2.88b	₹3.12b	₹3.37b	₹3.63b	₹3.90b
Growth Rate Estimate Source	Est @ 21.41%	Est @ 17.03%	Est @ 13.95%	Est @ 11.81%	Est @ 10.30%	Est @ 9.25%	Est @ 8.51%	Est @ 7.99%	Est @ 7.63%	Est @ 7.38%
Present Value (₹, Millions) Discounted @ 13%	₹1.4k	₹1.5k	₹1.5k	₹1.5k	₹1.4k	₹1.4k	₹1.3k	₹1.3k	₹1.2k	₹1.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹14b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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) = ₹3.9b× (1 + 6.8%) ÷ (13%– 6.8%) = ₹70b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹70b÷ ( 1 + 13%)¹⁰= ₹21b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹35b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of ₹606, the company appears about fair value at a 16% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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 Solara Active Pharma Sciences 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.

See our latest analysis for Solara Active Pharma Sciences

SWOT Analysis for Solara Active Pharma Sciences

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Solara Active Pharma Sciences, we've put together three fundamental items you should explore:

1. Risks: We feel that you should assess the 2 warning signs for Solara Active Pharma Sciences (1 is a bit concerning!) we've flagged before making an investment in the company.
2. Future Earnings: How does SOLARA'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.