Are Investors Undervaluing TSI Holdings Co.,Ltd. (TSE:3608) By 23%?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, TSI HoldingsLtd fair value estimate is JP¥1,231
• Current share price of JP¥944 suggests TSI HoldingsLtd is potentially 23% undervalued
• Peers of TSI HoldingsLtd are currently trading on average at a 79% premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of TSI Holdings Co.,Ltd. (TSE:3608) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 TSI HoldingsLtd

What's The Estimated Valuation?

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 begin with, we have to get estimates of 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.

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¥2.28b	JP¥2.47b	JP¥3.58b	JP¥4.17b	JP¥4.66b	JP¥5.04b	JP¥5.33b	JP¥5.55b	JP¥5.72b	JP¥5.85b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 16.51%	Est @ 11.63%	Est @ 8.22%	Est @ 5.83%	Est @ 4.16%	Est @ 2.99%	Est @ 2.17%
Present Value (¥, Millions) Discounted @ 6.0%	JP¥2.1k	JP¥2.2k	JP¥3.0k	JP¥3.3k	JP¥3.5k	JP¥3.6k	JP¥3.5k	JP¥3.5k	JP¥3.4k	JP¥3.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥31b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 6.0%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥5.8b× (1 + 0.3%) ÷ (6.0%– 0.3%) = JP¥102b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥102b÷ ( 1 + 6.0%)¹⁰= JP¥57b

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¥88b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of JP¥944, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. 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.

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 TSI HoldingsLtd 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 6.0%, which is based on a levered beta of 1.152. 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 TSI HoldingsLtd

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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 TSI HoldingsLtd, we've put together three fundamental items you should further research:

1. Risks: Every company has them, and we've spotted 1 warning sign for TSI HoldingsLtd you should know about.
2. Future Earnings: How does 3608'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.

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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.