Stock Analysis

Estimating The Fair Value Of Furukawa Electric Co., Ltd. (TSE:5801)

TSE:5801
Source: Shutterstock

Key Insights

  • The projected fair value for Furukawa Electric is JP¥3,689 based on 2 Stage Free Cash Flow to Equity
  • With JP¥4,145 share price, Furukawa Electric appears to be trading close to its estimated fair value
  • Analyst price target for 5801 is JP¥4,049, which is 9.8% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Furukawa Electric Co., Ltd. (TSE:5801) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Furukawa Electric

The Calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (¥, Millions) -JP¥11.3b -JP¥3.00b JP¥8.73b JP¥19.6b JP¥24.9b JP¥28.7b JP¥31.9b JP¥34.3b JP¥36.1b JP¥37.5b
Growth Rate Estimate Source Analyst x3 Analyst x1 Analyst x3 Analyst x2 Analyst x2 Est @ 15.41% Est @ 10.85% Est @ 7.65% Est @ 5.42% Est @ 3.85%
Present Value (¥, Millions) Discounted @ 9.7% -JP¥10.3k -JP¥2.5k JP¥6.6k JP¥13.5k JP¥15.7k JP¥16.5k JP¥16.7k JP¥16.3k JP¥15.7k JP¥14.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥103b

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 9.7%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = JP¥38b× (1 + 0.2%) ÷ (9.7%– 0.2%) = JP¥396b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥396b÷ ( 1 + 9.7%)10= JP¥157b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is JP¥260b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥4.1k, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
TSE:5801 Discounted Cash Flow August 1st 2024

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Furukawa Electric 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 9.7%, which is based on a levered beta of 1.688. 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 Furukawa Electric

Strength
  • No major strengths identified for 5801.
Weakness
  • Earnings declined over the past year.
  • Interest payments on debt are not well covered.
  • Dividend is low compared to the top 25% of dividend payers in the Electrical market.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow faster than the Japanese market.
Threat
  • Debt is not well covered by operating cash flow.
  • Paying a dividend but company has no free cash flows.
  • Annual revenue is forecast to grow slower than the Japanese market.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. For Furukawa Electric, we've compiled three additional items you should further examine:

  1. Risks: You should be aware of the 4 warning signs for Furukawa Electric (2 are a bit unpleasant!) we've uncovered before considering an investment in the company.
  2. Future Earnings: How does 5801'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

New: AI Stock Screener & Alerts

Our new AI Stock Screener scans the market every day to uncover opportunities.

• Dividend Powerhouses (3%+ Yield)
• Undervalued Small Caps with Insider Buying
• High growth Tech and AI Companies

Or build your own from over 50 metrics.

Explore Now for Free

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.