Estimating The Fair Value Of Colan Totte.Co.,Ltd. (TSE:7792)

Key Insights

• The projected fair value for Colan Totte.Co.Ltd is JP¥989 based on 2 Stage Free Cash Flow to Equity
• Current share price of JP¥850 suggests Colan Totte.Co.Ltd is potentially trading close to its fair value
• When compared to theindustry average discount to fair value of 25%, Colan Totte.Co.Ltd's competitors seem to be trading at a greater discount

In this article we are going to estimate the intrinsic value of Colan Totte.Co.,Ltd. (TSE:7792) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Colan Totte.Co.Ltd

The Method

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. To begin with, we have to get estimates of the next ten years of cash flows. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥512.3m	JP¥471.8m	JP¥446.1m	JP¥429.5m	JP¥418.6m	JP¥411.5m	JP¥406.9m	JP¥404.1m	JP¥402.4m	JP¥401.6m
Growth Rate Estimate Source	Est @ -11.39%	Est @ -7.89%	Est @ -5.45%	Est @ -3.73%	Est @ -2.54%	Est @ -1.70%	Est @ -1.11%	Est @ -0.70%	Est @ -0.41%	Est @ -0.21%
Present Value (¥, Millions) Discounted @ 4.8%	JP¥489	JP¥430	JP¥388	JP¥356	JP¥331	JP¥310	JP¥293	JP¥278	JP¥264	JP¥251

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥3.4b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.3%) 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 4.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥402m× (1 + 0.3%) ÷ (4.8%– 0.3%) = JP¥8.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥8.9b÷ ( 1 + 4.8%)¹⁰= JP¥5.5b

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¥8.9b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥850, the company appears about fair value at a 14% 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 Colan Totte.Co.Ltd 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 0.913. 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 Colan Totte.Co.Ltd

Moving On:

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 Colan Totte.Co.Ltd, we've put together three additional items you should further research:

1. Risks: Case in point, we've spotted 1 warning sign for Colan Totte.Co.Ltd you should be aware of.
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 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. 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.

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.

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