An Intrinsic Calculation For Fuji Electric Co., Ltd. (TSE:6504) Suggests It's 35% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Fuji Electric fair value estimate is JP¥10,117
• Fuji Electric is estimated to be 35% undervalued based on current share price of JP¥6,588
• Analyst price target for 6504 is JP¥8,736 which is 14% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Fuji Electric Co., Ltd. (TSE:6504) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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Step By Step Through 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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥56.8b	JP¥52.5b	JP¥49.0b	JP¥49.9b	JP¥85.0b	JP¥93.4b	JP¥99.2b	JP¥103.6b	JP¥106.9b	JP¥109.5b
Growth Rate Estimate Source	Analyst x3	Analyst x2	Analyst x4	Analyst x3	Analyst x1	Analyst x1	Est @ 6.20%	Est @ 4.45%	Est @ 3.23%	Est @ 2.37%
Present Value (¥, Millions) Discounted @ 6.6%	JP¥53.3k	JP¥46.2k	JP¥40.5k	JP¥38.7k	JP¥61.9k	JP¥63.8k	JP¥63.6k	JP¥62.3k	JP¥60.4k	JP¥58.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥549b

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 0.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥109b× (1 + 0.4%) ÷ (6.6%– 0.4%) = JP¥1.8t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥1.8t÷ ( 1 + 6.6%)¹⁰= JP¥942b

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¥1.5t. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥6.6k, the company appears quite good value at a 35% 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

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Fuji 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 6.6%, which is based on a levered beta of 1.173. 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 Fuji Electric

SWOT Analysis for Fuji Electric

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Fuji Electric, we've put together three further factors you should further examine:

1. Risks: For instance, we've identified 1 warning sign for Fuji Electric that you should be aware of.
2. Future Earnings: How does 6504'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. 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.

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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.