Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Hazama Ando fair value estimate is JP¥1,524
- Hazama Ando's JP¥1,144 share price signals that it might be 25% undervalued
- Our fair value estimate is 35% higher than Hazama Ando's analyst price target of JP¥1,125
Does the June share price for Hazama Ando Corporation (TSE:1719) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Hazama Ando
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (¥, Millions) | JP¥20.7b | JP¥15.8b | JP¥8.00b | JP¥10.1b | JP¥11.6b | JP¥12.8b | JP¥13.8b | JP¥14.5b | JP¥15.1b | JP¥15.5b |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 15.01% | Est @ 10.57% | Est @ 7.46% | Est @ 5.28% | Est @ 3.76% | Est @ 2.69% |
Present Value (¥, Millions) Discounted @ 6.3% | JP¥19.5k | JP¥14.0k | JP¥6.7k | JP¥7.9k | JP¥8.6k | JP¥8.9k | JP¥9.0k | JP¥8.9k | JP¥8.7k | JP¥8.4k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥101b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (0.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = JP¥15b× (1 + 0.2%) ÷ (6.3%– 0.2%) = JP¥254b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥254b÷ ( 1 + 6.3%)10= JP¥138b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is JP¥239b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥1.1k, the company appears a touch undervalued at a 25% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Hazama Ando 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 6.3%, which is based on a levered beta of 1.083. 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.
SWOT Analysis for Hazama Ando
- Debt is well covered by earnings.
- Dividend is in the top 25% of dividend payers in the market.
- Earnings declined over the past year.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company has no free cash flows.
- Annual earnings are forecast to grow slower than the Japanese market.
Next Steps:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Hazama Ando, we've put together three fundamental items you should assess:
- Risks: For example, we've discovered 2 warning signs for Hazama Ando (1 can't be ignored!) that you should be aware of before investing here.
- Future Earnings: How does 1719'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.
- 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSE every day. If you want to find the calculation for other stocks just search here.
Valuation is complex, but we're here to simplify it.
Discover if Hazama Ando might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
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About TSE:1719
Hazama Ando
Engages in the construction and construction-related business in Japan and internationally.
Excellent balance sheet average dividend payer.