A Look At The Fair Value Of Nippon Seiro Co., Ltd. (TSE:5010)

Key Insights

• The projected fair value for Nippon Seiro is JP¥258 based on 2 Stage Free Cash Flow to Equity
• With JP¥286 share price, Nippon Seiro appears to be trading close to its estimated fair value
• Industry average of 6.2% suggests Nippon Seiro's peers are currently trading at a lower premium to fair value

Does the November share price for Nippon Seiro Co., Ltd. (TSE:5010) 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 their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

Check out our latest analysis for Nippon Seiro

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. 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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥562.0m	JP¥540.6m	JP¥526.7m	JP¥517.7m	JP¥512.0m	JP¥508.6m	JP¥506.6m	JP¥505.8m	JP¥505.6m	JP¥506.0m
Growth Rate Estimate Source	Est @ -5.56%	Est @ -3.80%	Est @ -2.57%	Est @ -1.70%	Est @ -1.10%	Est @ -0.68%	Est @ -0.38%	Est @ -0.17%	Est @ -0.03%	Est @ 0.07%
Present Value (¥, Millions) Discounted @ 10%	JP¥510	JP¥445	JP¥393	JP¥350	JP¥314	JP¥283	JP¥256	JP¥231	JP¥210	JP¥190

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥3.2b

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 0.3%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥506m× (1 + 0.3%) ÷ (10%– 0.3%) = JP¥5.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥5.1b÷ ( 1 + 10%)¹⁰= JP¥1.9b

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¥5.1b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥286, 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 Nippon Seiro 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 10%, which is based on a levered beta of 2.000. 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 Nippon Seiro

Moving On:

Whilst important, the DCF calculation 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Nippon Seiro, we've compiled three fundamental elements you should assess:

1. Risks: Case in point, we've spotted 3 warning signs for Nippon Seiro you should be aware of, and 2 of them shouldn't be ignored.
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.

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.