An Intrinsic Calculation For OSG Corporation (TSE:6136) Suggests It's 40% Undervalued
Key Insights
- The projected fair value for OSG is JP¥3,166 based on 2 Stage Free Cash Flow to Equity
- OSG's JP¥1,915 share price signals that it might be 40% undervalued
- Analyst price target for 6136 is JP¥1,755 which is 45% below our fair value estimate
Does the July share price for OSG Corporation (TSE:6136) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.
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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
The Calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | 2035 | |
Levered FCF (¥, Millions) | JP¥10.00b | JP¥12.2b | JP¥14.5b | JP¥15.6b | JP¥16.4b | JP¥16.9b | JP¥17.4b | JP¥17.7b | JP¥18.0b | JP¥18.2b |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Analyst x1 | Analyst x1 | Est @ 4.84% | Est @ 3.53% | Est @ 2.60% | Est @ 1.96% | Est @ 1.51% | Est @ 1.19% |
Present Value (¥, Millions) Discounted @ 6.7% | JP¥9.4k | JP¥10.7k | JP¥11.9k | JP¥12.0k | JP¥11.8k | JP¥11.4k | JP¥11.0k | JP¥10.5k | JP¥10.0k | JP¥9.5k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥108b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.4%) 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 6.7%.
Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = JP¥18b× (1 + 0.4%) ÷ (6.7%– 0.4%) = JP¥290b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥290b÷ ( 1 + 6.7%)10= JP¥151b
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¥259b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of JP¥1.9k, the company appears quite good value at a 40% 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.
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 OSG 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 6.7%, which is based on a levered beta of 1.195. 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.
Check out our latest analysis for OSG
SWOT Analysis for OSG
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Machinery market.
- Annual earnings are forecast to grow for the next 3 years.
- Trading below our estimate of fair value by more than 20%.
- Annual earnings are forecast to grow slower than the Japanese market.
Moving On:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. What is the reason for the share price sitting below the intrinsic value? For OSG, we've put together three pertinent items you should assess:
- Risks: You should be aware of the 1 warning sign for OSG we've uncovered before considering an investment in the company.
- Future Earnings: How does 6136'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.
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.
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.
About TSE:6136
OSG
Manufactures and sells cutting tools in Japan, the Americas, Europe, Africa, and Asia.
Flawless balance sheet, good value and pays a dividend.
Market Insights
Community Narratives
