Calculating The Intrinsic Value Of Skylark Holdings Co., Ltd. (TSE:3197)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Skylark Holdings fair value estimate is JP¥2,446
• With JP¥2,067 share price, Skylark Holdings appears to be trading close to its estimated fair value
• Analyst price target for 3197 is JP¥1,983 which is 19% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Skylark Holdings Co., Ltd. (TSE:3197) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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

View our latest analysis for Skylark Holdings

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 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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥42.0b	JP¥44.6b	JP¥41.6b	JP¥39.6b	JP¥38.4b	JP¥37.5b	JP¥37.0b	JP¥36.6b	JP¥36.4b	JP¥36.2b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ -6.78%	Est @ -4.68%	Est @ -3.22%	Est @ -2.19%	Est @ -1.47%	Est @ -0.97%	Est @ -0.62%	Est @ -0.37%
Present Value (¥, Millions) Discounted @ 6.9%	JP¥39.3k	JP¥39.0k	JP¥34.0k	JP¥30.3k	JP¥27.5k	JP¥25.1k	JP¥23.2k	JP¥21.5k	JP¥20.0k	JP¥18.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥279b

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (0.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥36b× (1 + 0.2%) ÷ (6.9%– 0.2%) = JP¥542b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥542b÷ ( 1 + 6.9%)¹⁰= JP¥278b

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¥557b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of JP¥2.1k, the company appears about fair value at a 16% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Skylark Holdings 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 6.9%, which is based on a levered beta of 1.190. 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 Skylark Holdings

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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. 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 Skylark Holdings, we've put together three important elements you should consider:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Skylark Holdings .
2. Future Earnings: How does 3197'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. 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.

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