Calculating The Fair Value Of Hino Motors, Ltd. (TSE:7205)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Hino Motors fair value estimate is JP¥360
• With JP¥419 share price, Hino Motors appears to be trading close to its estimated fair value
• Our fair value estimate is 20% lower than Hino Motors' analyst price target of JP¥452

In this article we are going to estimate the intrinsic value of Hino Motors, Ltd. (TSE:7205) by taking the forecast future cash flows of the company and discounting them back 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.

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.

See our latest analysis for Hino Motors

Crunching The Numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	-JP¥32.5b	-JP¥27.7b	JP¥7.20b	JP¥13.8b	JP¥19.4b	JP¥24.9b	JP¥29.8b	JP¥34.0b	JP¥37.4b	JP¥40.0b
Growth Rate Estimate Source	Analyst x3	Analyst x4	Analyst x3	Analyst x2	Est @ 40.42%	Est @ 28.36%	Est @ 19.91%	Est @ 14.00%	Est @ 9.86%	Est @ 6.96%
Present Value (¥, Millions) Discounted @ 10%	-JP¥29.5k	-JP¥22.9k	JP¥5.4k	JP¥9.4k	JP¥12.0k	JP¥14.0k	JP¥15.3k	JP¥15.8k	JP¥15.8k	JP¥15.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥51b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 0.2%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥40b× (1 + 0.2%) ÷ (10%– 0.2%) = JP¥406b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥406b÷ ( 1 + 10%)¹⁰= JP¥156b

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¥206b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥419, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Hino Motors 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 10%, which is based on a levered beta of 1.750. 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 Hino Motors

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. For Hino Motors, we've put together three additional items you should further research:

1. Risks: For example, we've discovered 2 warning signs for Hino Motors that you should be aware of before investing here.
2. Future Earnings: How does 7205'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 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.

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.

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