Calculating The Intrinsic Value Of ITOCHU-SHOKUHIN Co., Ltd. (TSE:2692)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, ITOCHU-SHOKUHIN fair value estimate is JP¥9,920
• ITOCHU-SHOKUHIN's JP¥11,240 share price indicates it is trading at similar levels as its fair value estimate
• Industry average of 166% suggests ITOCHU-SHOKUHIN's peers are currently trading at a higher premium to fair value

Does the December share price for ITOCHU-SHOKUHIN Co., Ltd. (TSE:2692) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. 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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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. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (¥, Millions)	JP¥7.01b	JP¥6.37b	JP¥5.97b	JP¥5.72b	JP¥5.56b	JP¥5.46b	JP¥5.41b	JP¥5.38b	JP¥5.37b	JP¥5.37b
Growth Rate Estimate Source	Est @ -13.38%	Est @ -9.18%	Est @ -6.25%	Est @ -4.19%	Est @ -2.76%	Est @ -1.75%	Est @ -1.04%	Est @ -0.55%	Est @ -0.21%	Est @ 0.04%
Present Value (¥, Millions) Discounted @ 4.8%	JP¥6.7k	JP¥5.8k	JP¥5.2k	JP¥4.7k	JP¥4.4k	JP¥4.1k	JP¥3.9k	JP¥3.7k	JP¥3.5k	JP¥3.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥45b

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 0.6%. We discount the terminal cash flows to today's value at a cost of equity of 4.8%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = JP¥5.4b× (1 + 0.6%) ÷ (4.8%– 0.6%) = JP¥129b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥129b÷ ( 1 + 4.8%)¹⁰= JP¥80b

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¥126b. 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¥11k, 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 ITOCHU-SHOKUHIN 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 4.8%, which is based on a levered beta of 0.800. 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.

View our latest analysis for ITOCHU-SHOKUHIN

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. 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 ITOCHU-SHOKUHIN, we've put together three further elements you should assess:

1. Risks: For example, we've discovered 1 warning sign for ITOCHU-SHOKUHIN that you should be aware of before investing here.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.