Compelling narrative or improving numbers? This has been the bone of contention between us fellow investors when it comes to the prospects of Laurus. I would like to add my two cents with numbers:
I did a Michael Mauboussin’s Price Implied Forecast to see what kind of future expectations are built in the current price of Laurus Labs.
As Michael Mauboussin refers to Miller & Modigliani model:
Value of a firm = steady-state value + future value
The steady-state value of the firm, calculated using the perpetuity method, assumes that NOPAT is sustainable indefinitely and that incremental investments will neither add, nor subtract, value.
Steady state value = Normalized NOPAT/cost of capital + cash - debt
Steady state value - Assuming 12% cost of capital, steady state value of equity is 8555 Cr.
Future value creation boils down to how much money a company invests, what spread that investment earns relative to the cost of capital, and for how long a company can find value-creating opportunities.
Future Value = Investment (ROIC – cost of capital) * competitive advantage period/ (cost of capital(1+cost of capital))**
Key drivers of value creation:
- Spread between ROIIC & Cost of capital
- Size of reinvestment
- For how long a company can keep reinvesting
Historically, ROIIC has been well above cost of capital.
Current investment = 5000 Cr
Cost of capital = 12%
ROIC = 20%
Competitive advantage period : In his book Expectations Investing, Michael Mauboussin explains that market always takes a long term view and market’s expectations are embedded in the current price. In order to calculate Price Implied Forecast (PIE) period (for how long does the market expect company to maintain its competitive advantage before declining to a phase where reinvestment earns no more than the cost of capital), I have assumed these inputs -
Why 22% Sales growth rate? It gives me 7000 Cr revenue by FY24 which I believe is a reasonable estimate. If not 60% revenue growth this year alone, which many believe is quite achievable, a 35-40% kind of growth in FY23 should take care of (further de-growth hence) 22% growth assumption in years to come.
Operating margins: Simply took 5 year avg margins at 23%
Incremental fixed capital and working capital investments have been well over 30% in the past. Both should be going down in coming years in my opinion so assumed 20% for each. Other value determinant could be inflation rate which I have assumed 4% here.
So according to Mauboussin’s expectations investing and my (un)reasonable assumptions, current price implies 9 years of competitive advantage when Laurus can reinvest, earn over its cost of capital and add value.
Current investment = 5000 Cr
Cost of capital = 12%
ROIC = 20%
Competitive advantage period = 9 years
Future value = 5000* (20%-12%)9/(12%(1+12%)) = 26785 Cr
Value of a firm = steady-state value + future value
Total value = 8555+26785 ~ 35300 Cr
Current market price ~ 28000 Cr
Now, you may assume 5% inflation instead of 4% or a totally different reinvestment rate and market value will fluctuate accordingly. But the idea is, I am not exactly trying to do a DCF here. I do not intend to discount future cash flows at 10.978% cost of capital to get the present value. I am only interested in finding out what current price implies and what kind of market expectations are embedded in it. Provided my assumptions aren’t highly erroneous, Laurus doesn’t look overpriced at the moment.
Price implied expectation.xlsx (123.9 KB)
