A Look At The Intrinsic Value Of KFC Holdings Japan, Ltd. (TSE:9873)

Key Insights

• KFC Holdings Japan's estimated fair value is JP¥4,792 based on 2 Stage Free Cash Flow to Equity
• With JP¥5,120 share price, KFC Holdings Japan appears to be trading close to its estimated fair value
• When compared to theindustry average discount of -278%, KFC Holdings Japan's competitors seem to be trading at a greater premium to fair value

Does the April share price for KFC Holdings Japan, Ltd. (TSE:9873) 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. 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.

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for KFC Holdings Japan

The Calculation

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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (¥, Millions)	JP¥6.11b	JP¥6.33b	JP¥6.49b	JP¥6.61b	JP¥6.70b	JP¥6.77b	JP¥6.82b	JP¥6.85b	JP¥6.88b	JP¥6.91b
Growth Rate Estimate Source	Est @ 5.06%	Est @ 3.59%	Est @ 2.56%	Est @ 1.84%	Est @ 1.34%	Est @ 0.98%	Est @ 0.74%	Est @ 0.56%	Est @ 0.44%	Est @ 0.36%
Present Value (¥, Millions) Discounted @ 6.4%	JP¥5.7k	JP¥5.6k	JP¥5.4k	JP¥5.2k	JP¥4.9k	JP¥4.7k	JP¥4.4k	JP¥4.2k	JP¥3.9k	JP¥3.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥48b

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 0.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = JP¥6.9b× (1 + 0.2%) ÷ (6.4%– 0.2%) = JP¥111b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥111b÷ ( 1 + 6.4%)¹⁰= JP¥59b

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¥107b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥5.1k, 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

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. 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 KFC Holdings Japan 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 6.4%, which is based on a levered beta of 1.111. 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.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For KFC Holdings Japan, there are three relevant aspects you should look at:

1. Financial Health: Does 9873 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. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.