Is Avanti Feeds at a fair value? How do you determine the fair value of any stock?
Prof. Aswath Damodaran, the authority on all things Valuation, once said concisely: “The value of a firm is a function of three variables—its capacity to generate cash flows, its expected growth in these cash flows, and the uncertainty associated with these cash flows.”Honestly, that’s all there is to it.We will approach this Valuation step-by-step, starting by filling out the financial details of Avanti Feeds.The NumbersI have filled out the following information from Avanti Feed’s Q4 Results 2018 / Full Year Results 2017–18 (Feel free to dig around in the PDF and locate all the information):The ‘Minority Interests’ are Avanti Feeds’ subsidiary holdings. I have applied a 5x multiplier to the actual Net Assets number provided in the PDF. 5 is kind of a conservative average Price-to-Book Ratio of the Food Processing Industry in India.Some other data like Industry Beta, Industry D/E, Indexed Returns etc., have been acquired from simple online searches. As you will see later, these are just fillers and I won’t be using them anywhere (I still have to enter the details, because my model doesn’t work unless all the information is filled out). This is just clerical work. So, we’re done here.The AssumptionsThe following are my assumptions regarding Avanti Feeds’ future business performance. Some of the key things to note here:I have assumed a period of 15 Years before Avanti Feeds becomes a ‘mature’ company. Given how Avanti Feeds is a 8000+ Cr Market Cap company with no real Competitive Advantage, even 15 Years is stretching it a little bit. But let’s give Avanti the advantage of the doubt.The Shrimp Exports Industry, as I’d mentioned in my other answer, is cyclical. Avanti Feeds supplies foods to Shrimp Producers and suffers from the same cycle as well. So, I’m going to assume that the Sales Growth Rate will drop quickly. In the Terminal Year (‘After Year 15’), Avanti will grow at more or less the Growth Rate of the Indian Economy, which I’ve pegged at 5%, which once again, is optimistic to boot.The Shrimp Industry has no pricing power and has only been riding on the discovery of the Vannameni Shrimp. I have assumed that over time, the benefits of the new species will fade away and so too will Avanti’s Operating Margins. In the Terminal Year, Avanti’s Margin will closely resemble the Margins of the Food Processing Industry in India (Dataset acquired from Useful Data Sets).The Corporate Tax Rate in India is 25%, no surprises there.The Capital Turnover Ratio of Avanti Feeds has been healthy (4) in its long history. I prefer taking long-term Average for assumptions, hence I took a 5-year Average, which turned out to be 4.87. By repeating the Ratio till 15 years, I assume that there will no technological disruptions or economies that will enable Avanti to be more productive that it is currently. The Terminal Year Capital Turnover is automatically calculated after several iterations of Sales Growth and Return on Capital figures (Specifically, a Ratio of Marginal Sales Growth to Marginal Return on Capital).Depreciation has been quite low for Avanti, which is understandable for a Shrimp Feed producer. The 5-year Average has been 1% and I have repeated the same.Once again consulting Useful Data Sets, I found out that the WACC of the Food Processing Industry in India is 15.43%, which will become the Discounting Rate. There are of course, other ways to arrive at the Discounting Rate. But Avanti Feeds is an industry where there aren’t many comparable companies. So as a rule of thumb, I always take the broader Industry Average (If there were such comparable, I could discount using the Bottom-up Beta-based CAPM WACC instead). In the Terminal Year, the Discounting Rate drops to Risk-free Rate (8.22%) + Global Average Market Risk Premium (5%).This is how my assumptions look like in one picture:The CashflowsThe Cashflows of Avanti Feeds are then calculated like so, based on the above assumptions:Of course, the next step would be to discount these Cash Flows at an appropriate Discounting Rate.The ValueFinally, this is what I believe the Instrinsic Value of Avanti Feeds to be. A few things to pan out before that:If you know Probability Theory, you will appreciate that at any point in time, a company has a non-zero chance to shut down in the near future. That percentage is 5% for Avanti Feeds, is what I’ve assumed. If you think this step is unnecessary, don’t worry, this affects the Value of Avanti Feeds only by a few percentage points. This is more of a step to satisfy my pet peeve for being objectively correct.I have applied a Margin of Safety of 10%—you know, as Benjamin Graham once said: “The function of the Margin of Safety, in essence, is that of rendering unnecessary an accurate estimate of the future.” It’s a simple agreement to the fact that Value is in the future and the future is unknown. It (Literally) pays to be a skeptical and measured. In fact, I generally apply a Margin of Safety of at least 30% for all my actual Investment prospects. But that’s just me, so I’ve capped it at 10% here.I believe that Avanti Feeds is purchasable at a price of Rs. 1048.93. Even if you remove the Margin of Safety and maybe beef up the Growth and Capital Turnover numbers a little bit, Avanti Feeds’ Value would still be below the Current Market Price. It shows that Avanti Feeds, regardless of its prospects, is grossly overvalued.FootnotesThe question talks only about Value/Price. My answer was on the lines of the Price at which Avanti Feeds can be bought. In short, it showed how much to pay for Avanti Feeds. It does not tell you whether or not you should pay at all. If you want to explore my qualitative views on the company, you should refer the post I wrote a few months back: Dinesh Sairam (தினேஷ் சாய்ராம்)'s answer to Is Avanti Feed good for long-term investment?Of course, the Value is attached to all the assumptions I made regarding the stock. If you think the assumptions I made are incorrect, then my Value would be incorrect for you to fixate on as well.The excel model I used for this was an impromptu one I put together just to answer this question. The proper version of the Excel Sheet I used for this calculation is here: Numbers and Narratives (Although a different company has been Valued in the sheet— KRBL). Here is a post on how to use my Excel model: Numbers and Narratives: A Simple Discounted Cash Flow (DCF) Model for Equity Valuation. Feel free to tell your own story about Avanti Feeds and find out its Intrinsic Value for you personally (And let me know in the comments or in the blog post).This was largely a napkin-back Valuation, rather than a full-fledged one (For want of space). For more detailed answers and Valuation-related content, visit my blog, Valuation in Motion. Consider subscribing to my blog if you found my answer meaningful.