Case 040Stock pitch and thesis defenceCore

Pitch a beverages company and cross-check the valuation: it trades at 35 times earnings, while a DCF with free cash flow of Rs 300 crore growing 15% for five years, then 6%, at an 11.5% discount rate gives a different answer. Find the assumption that reconciles the two.

SchrodersLondon · 2024SchrodersLondon · 2024

The situation

Ketaki Beverages makes packaged juices and flavoured dairy drinks, sold mostly in western and southern India. It earns net profit of Rs 360 crore and trades at 35 times earnings, a market value of Rs 12,600 crore, with no net debt. Listed beverage and food peers trade between 28 and 40 times earnings.

Your DCF: free cash flow of Rs 300 crore this year, growing 15% a year for 5 years, then 6% for ever, discounted at 11.5%. You are about to pitch the stock, and the two methods disagree.

Your task

What does the DCF say Ketaki is worth, why does it differ from the market's 35 times, and what single assumption would reconcile them?

Quick check

Does the DCF value Ketaki above or below its market value?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The DCF gives about Rs 8,395 crore, 23 times earnings, against a market value of Rs 12,600 crore, and the gap closes if Ketaki grows at 15% for about 12 years instead of five. The same gap could be closed by 8.0% growth for ever or a 9.7% discount rate, but those are harder to defend. The pitch therefore becomes a question: can Ketaki sustain 15% growth for more than a decade?

Step 1What does the DCF say, piece by piece?

Split the value into the years you forecast and everything after. Cash flow grows from Rs 300 crore to about Rs 603 crore by year five; those five years are worth about Rs 1,647 crore today. After that, growth of 6% for ever at an 11.5% discount rate is worth about Rs 6,748 crore today. The DCF total is about Rs 8,395 crore, 80% of it from the terminal value, and that is only 23 times this year's earnings.

The relationship
V=∑t=15300×1.15t1.115t+603.4×1.06(0.115−0.06)×1.1155≈1,647+6,748=8,395V = \sum_{t=1}^{5} \frac{300 \times 1.15^{t}}{1.115^{t}} + \frac{603.4 \times 1.06}{(0.115 - 0.06) \times 1.115^{5}} \approx 1{,}647 + 6{,}748 = 8{,}395
300 x 1.15^tfree cash flow in year t, Rs crore
603.4free cash flow in year five
0.115 - 0.06discount rate minus perpetual growth
What it says in wordsFive years of cash flow are worth about Rs 1,647 crore and everything after about Rs 6,748 crore, a total of Rs 8,395 crore.
Step 2Which assumption closes the gap to 35 times?

Do not average the two numbers; ask what the market must believe. Solve for each input in turn. Holding everything else, the market price implies either 15% growth for about 12 years instead of five, or perpetual growth of 8.0% instead of 6%, or a discount rate of 9.7% instead of 11.5%. Perpetual growth of 8% is close to the whole economy's nominal growth for ever, and a discount rate below 10% for a mid-sized consumer company is hard to justify. A long runway of fast growth is the only one of the three a business can actually earn.

Where the price sits against each method, equity value in Rs crore6,0008,00010,00012,00014,00016,000Peer P/E, 28x to 40x10,08014,400DCF, 5 years of 15%6,29112,891DCF, 10 to 14 years of 15%11,44614,249base 8,395Price today: 12,600 (35x)Equity value, Rs crore; Ketaki has no net debt
Ketaki's Rs 12,600 crore market value sits inside the peer multiple range and above almost all of the five-year DCF range, but inside the range for a DCF that assumes 10 to 14 years of 15% growth, so the price is a bet on the length of the growth runway.
What the market could be assumingNeeded to reach Rs 12,600 croreOur base casePlausible?
Years of 15% growthabout 125Possible, needs evidence
Perpetual growth after year five8.0%6.0%Unlikely
Discount rate9.7%11.5%Unlikely
The market price reconciles with the DCF if Ketaki grows at 15% for about 12 years, if perpetual growth is 8.0%, or if the discount rate is 9.7%, and only the first is a claim about the business.
Step 3How does that shape the pitch?

The pitch now has a precise test. If you believe Ketaki can grow cash flow 15% a year for well over a decade, through new states, new categories or more outlets, the stock is fairly priced or cheap; if you believe the runway is five to seven years, it is worth closer to Rs 8,395 to 9,559 crore. Evidence that would support the long runway: distribution reach still well below the leading national brands, volume rather than price driving growth, and new categories reaching scale. Evidence against: growth leaning on price increases, rising spending on promotions to hold share, and a flat or falling repeat purchase rate. State which side you are on and why; that is the pitch.

Where candidates lose it

The usual loss is picking one method and dismissing the other: either the DCF is right and the market is wrong, or the multiple is right and the DCF is too conservative. Interviewers want the reconciling assumption, not a verdict on the methods.

The second is closing the gap by nudging the discount rate or terminal growth until the numbers match. A 2-point change in either is not an analysis; a claim about how long the business can grow is.

What the interviewer asks next

  • What is Ketaki worth if growth is 15% for five years, then fades to 6% over five more years?
  • Peers trade at 28 to 40 times. Why is that range such a weak anchor?
  • Which three numbers from Ketaki's next annual report would move your view most?

Asked at Schroders, Investment Management, London, 2024 (Wall Street Oasis): I was asked to do a stock pitch as well as equity valuation questions
Asked at Schroders, Investment Management, London, 2024 (Wall Street Oasis): Asked to do a stock pitch. Candidates were asked questions specific to their degree backgrounds.

Company names and figures are illustrative.