Are Investors Undervaluing Teijin Limited (TSE:3401) By 45%?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Teijin fair value estimate is JP¥2,032
• Teijin's JP¥1,127 share price signals that it might be 45% undervalued
• Analyst price target for 3401 is JP¥1,270 which is 38% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Teijin Limited (TSE:3401) by projecting its future cash flows and then discounting them to today's value. This will be done using 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.

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.

We've discovered 2 warning signs about Teijin. View them for free.

The Calculation

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥99.5b	JP¥13.7b	JP¥34.2b	JP¥24.5b	JP¥29.2b	JP¥32.1b	JP¥34.5b	JP¥36.3b	JP¥37.6b	JP¥38.6b
Growth Rate Estimate Source	Analyst x1	Analyst x3	Analyst x2	Analyst x2	Analyst x2	Est @ 10.22%	Est @ 7.27%	Est @ 5.20%	Est @ 3.75%	Est @ 2.74%
Present Value (¥, Millions) Discounted @ 10%	JP¥90.3k	JP¥11.3k	JP¥25.5k	JP¥16.6k	JP¥17.9k	JP¥17.9k	JP¥17.4k	JP¥16.6k	JP¥15.6k	JP¥14.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥244b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 0.4%. 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¥39b× (1 + 0.4%) ÷ (10%– 0.4%) = JP¥393b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥393b÷ ( 1 + 10%)¹⁰= JP¥148b

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¥392b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥1.1k, the company appears quite good value at a 45% discount to where the stock price trades currently. 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. 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 Teijin 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 1.875. 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.

Check out our latest analysis for Teijin

SWOT Analysis for Teijin

Looking Ahead:

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. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Teijin, there are three pertinent aspects you should explore:

1. Risks: Take risks, for example - Teijin has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
2. Future Earnings: How does 3401'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 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.

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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.