Stock Analysis
Kagome Co., Ltd.'s (TSE:2811) Intrinsic Value Is Potentially 40% Above Its Share Price
Key Insights
- The projected fair value for Kagome is JP¥4,867 based on 2 Stage Free Cash Flow to Equity
- Current share price of JP¥3,481 suggests Kagome is potentially 28% undervalued
Today we will run through one way of estimating the intrinsic value of Kagome Co., Ltd. (TSE:2811) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for Kagome
The Model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (¥, Millions) | JP¥15.3b | JP¥16.1b | JP¥17.0b | JP¥17.9b | JP¥18.5b | JP¥18.9b | JP¥19.2b | JP¥19.5b | JP¥19.7b | JP¥19.8b |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 3.36% | Est @ 2.41% | Est @ 1.75% | Est @ 1.29% | Est @ 0.96% | Est @ 0.73% |
Present Value (¥, Millions) Discounted @ 4.7% | JP¥14.6k | JP¥14.7k | JP¥14.8k | JP¥14.9k | JP¥14.7k | JP¥14.3k | JP¥13.9k | JP¥13.5k | JP¥13.0k | JP¥12.5k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥141b
The second stage is also known as Terminal Value, this is the business's cash flow after 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 4.7%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = JP¥20b× (1 + 0.2%) ÷ (4.7%– 0.2%) = JP¥441b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥441b÷ ( 1 + 4.7%)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¥419b. 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¥3.5k, the company appears a touch undervalued at a 28% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
The 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 Kagome 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 4.7%, 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.
SWOT Analysis for Kagome
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Dividends are covered by earnings and cash flows.
- Dividend is low compared to the top 25% of dividend payers in the Food market.
- Trading below our estimate of fair value by more than 20%.
- Debt is not well covered by operating cash flow.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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. Why is the intrinsic value higher than the current share price? For Kagome, we've put together three important factors you should consider:
- Risks: For example, we've discovered 2 warning signs for Kagome that you should be aware of before investing here.
- Future Earnings: How does 2811'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.
- 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.
Valuation is complex, but we're here to simplify it.
Discover if Kagome might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
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About TSE:2811
Kagome
Manufactures, purchases, and sells food products in Japan and internationally.