Stock Analysis
An Intrinsic Calculation For Komatsu Ltd. (TSE:6301) Suggests It's 50% Undervalued
Key Insights
- The projected fair value for Komatsu is JP¥8,028 based on 2 Stage Free Cash Flow to Equity
- Current share price of JP¥4,028 suggests Komatsu is potentially 50% undervalued
- The JP¥4,582 analyst price target for 6301 is 43% less than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Komatsu Ltd. (TSE:6301) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for Komatsu
Is Komatsu Fairly Valued?
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 start off with, we need to estimate 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (¥, Millions) | JP¥391.4b | JP¥367.7b | JP¥360.8b | JP¥409.0b | JP¥426.4b | JP¥438.2b | JP¥447.0b | JP¥453.6b | JP¥458.7b | JP¥462.6b |
Growth Rate Estimate Source | Analyst x6 | Analyst x6 | Analyst x4 | Analyst x2 | Analyst x2 | Est @ 2.76% | Est @ 2.01% | Est @ 1.49% | Est @ 1.12% | Est @ 0.86% |
Present Value (¥, Millions) Discounted @ 6.1% | JP¥368.8k | JP¥326.5k | JP¥301.9k | JP¥322.4k | JP¥316.8k | JP¥306.7k | JP¥294.9k | JP¥282.0k | JP¥268.7k | JP¥255.4k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥3.0t
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.1%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = JP¥463b× (1 + 0.3%) ÷ (6.1%– 0.3%) = JP¥7.9t
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥7.9t÷ ( 1 + 6.1%)10= JP¥4.4t
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¥7.4t. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥4.0k, the company appears quite undervalued at a 50% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Komatsu 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 6.1%, which is based on a levered beta of 1.177. 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 Komatsu
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Dividend is in the top 25% of dividend payers in the market.
- Earnings growth over the past year is below its 5-year average.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow slower than the Japanese market.
Looking Ahead:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For Komatsu, we've put together three additional factors you should assess:
- Risks: You should be aware of the 1 warning sign for Komatsu we've uncovered before considering an investment in the company.
- Future Earnings: How does 6301'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. Simply Wall St updates its DCF calculation for every Japanese stock every day, so if you want to find the intrinsic value of any other stock just search here.
Valuation is complex, but we're here to simplify it.
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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.
About TSE:6301
Komatsu
Manufactures and sells construction, mining, and utility equipment in Japan, the Americas, Europe, China, Rest of Asia, Oceania, the Middle East, Africa, and CIS countries.