Stock Analysis

Is Rinnai Corporation (TSE:5947) Expensive For A Reason? A Look At Its Intrinsic Value

Published
TSE:5947

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Rinnai fair value estimate is JP¥2,664
  • Rinnai is estimated to be 24% overvalued based on current share price of JP¥3,309
  • Analyst price target for 5947 is JP¥4,060, which is 52% above our fair value estimate

In this article we are going to estimate the intrinsic value of Rinnai Corporation (TSE:5947) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Rinnai

Step By Step Through The Calculation

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) forecast

2025202620272028202920302031203220332034
Levered FCF (¥, Millions) JP¥20.2bJP¥17.0bJP¥23.0bJP¥23.4bJP¥23.8bJP¥24.0bJP¥24.2bJP¥24.4bJP¥24.5bJP¥24.7b
Growth Rate Estimate SourceAnalyst x2Analyst x2Analyst x2Est @ 1.93%Est @ 1.44%Est @ 1.10%Est @ 0.87%Est @ 0.70%Est @ 0.58%Est @ 0.50%
Present Value (¥, Millions) Discounted @ 6.5% JP¥18.9kJP¥14.9kJP¥19.0kJP¥18.2kJP¥17.4kJP¥16.5kJP¥15.6kJP¥14.8kJP¥13.9kJP¥13.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥162b

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 6.5%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = JP¥25b× (1 + 0.3%) ÷ (6.5%– 0.3%) = JP¥400b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥400b÷ ( 1 + 6.5%)10= JP¥214b

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¥376b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥3.3k, the company appears slightly overvalued at the time of writing. 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.

TSE:5947 Discounted Cash Flow January 17th 2025

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 Rinnai 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 6.5%, which is based on a levered beta of 1.241. 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 Rinnai

Strength
  • Earnings growth over the past year exceeded the industry.
  • Currently debt free.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Consumer Durables market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio compared to estimated Fair P/E ratio.
Threat
  • Annual earnings are forecast to grow slower than the Japanese market.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Can we work out why the company is trading at a premium to intrinsic value? For Rinnai, we've compiled three essential items you should explore:

  1. Financial Health: Does 5947 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does 5947'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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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.