Is There An Opportunity With Tokyo Ohka Kogyo Co., Ltd.'s (TSE:4186) 34% Undervaluation?
Key Insights
- Tokyo Ohka Kogyo's estimated fair value is JP¥5,459 based on 2 Stage Free Cash Flow to Equity
- Current share price of JP¥3,629 suggests Tokyo Ohka Kogyo is potentially 34% undervalued
- The JP¥4,771 analyst price target for 4186 is 13% less than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Tokyo Ohka Kogyo Co., Ltd. (TSE:4186) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
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. 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.
Check out our latest analysis for Tokyo Ohka Kogyo
The Method
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. 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.
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) forecast
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (¥, Millions) | JP¥16.1b | JP¥19.7b | JP¥27.6b | JP¥29.6b | JP¥30.9b | JP¥31.9b | JP¥32.6b | JP¥33.2b | JP¥33.6b | JP¥34.0b |
Growth Rate Estimate Source | Analyst x6 | Analyst x7 | Analyst x3 | Analyst x3 | Est @ 4.49% | Est @ 3.22% | Est @ 2.33% | Est @ 1.71% | Est @ 1.28% | Est @ 0.97% |
Present Value (¥, Millions) Discounted @ 5.0% | JP¥15.4k | JP¥17.9k | JP¥23.9k | JP¥24.4k | JP¥24.2k | JP¥23.8k | JP¥23.2k | JP¥22.5k | JP¥21.7k | JP¥20.9k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥218b
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. 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 5.0%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = JP¥34b× (1 + 0.3%) ÷ (5.0%– 0.3%) = JP¥721b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥721b÷ ( 1 + 5.0%)10= JP¥444b
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¥662b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥3.6k, the company appears quite undervalued at a 34% 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
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 Tokyo Ohka Kogyo 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 5.0%, which is based on a levered beta of 0.948. 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 Tokyo Ohka Kogyo
- Debt is not viewed as a risk.
- Earnings growth over the past year underperformed the Chemicals industry.
- Dividend is low compared to the top 25% of dividend payers in the Chemicals market.
- Annual earnings are forecast to grow faster than the Japanese market.
- Trading below our estimate of fair value by more than 20%.
- Dividends are not covered by cash flow.
- Revenue is forecast to grow slower than 20% per year.
Next Steps:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Tokyo Ohka Kogyo, we've compiled three essential items you should look at:
- Risks: Every company has them, and we've spotted 1 warning sign for Tokyo Ohka Kogyo you should know about.
- Future Earnings: How does 4186'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. 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.
Valuation is complex, but we're here to simplify it.
Discover if Tokyo Ohka Kogyo might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
Access Free AnalysisHave 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.
About TSE:4186
Tokyo Ohka Kogyo
Manufactures and sells chemical products and process equipment in Japan and internationally.
Flawless balance sheet and fair value.