Stock Analysis
- Japan
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- Interactive Media and Services
- /
- TSE:4689
Is There An Opportunity With LY Corporation's (TSE:4689) 46% Undervaluation?
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, LY fair value estimate is JP¥698
- Current share price of JP¥379 suggests LY is potentially 46% undervalued
- Our fair value estimate is 43% higher than LY's analyst price target of JP¥488
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of LY Corporation (TSE:4689) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 LY
The Calculation
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 start off with, we need to estimate 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, 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) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (¥, Millions) | JP¥171.2b | JP¥240.2b | JP¥271.5b | JP¥320.5b | JP¥350.3b | JP¥370.6b | JP¥386.0b | JP¥397.5b | JP¥406.1b | JP¥412.5b |
Growth Rate Estimate Source | Analyst x2 | Analyst x3 | Analyst x3 | Analyst x1 | Analyst x1 | Est @ 5.80% | Est @ 4.14% | Est @ 2.98% | Est @ 2.16% | Est @ 1.59% |
Present Value (¥, Millions) Discounted @ 7.1% | JP¥159.8k | JP¥209.3k | JP¥220.8k | JP¥243.2k | JP¥248.1k | JP¥245.0k | JP¥238.2k | JP¥228.9k | JP¥218.3k | JP¥207.0k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥2.2t
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 0.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = JP¥413b× (1 + 0.3%) ÷ (7.1%– 0.3%) = JP¥6.0t
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥6.0t÷ ( 1 + 7.1%)10= JP¥3.0t
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¥5.2t. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of JP¥379, the company appears quite good value at a 46% 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. 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 LY 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 7.1%, which is based on a levered beta of 1.382. 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 LY
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Interactive Media and Services market.
- Annual earnings are forecast to grow faster than the Japanese market.
- Good value based on P/E ratio and estimated fair value.
- Revenue is forecast to grow slower than 20% per year.
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For LY, we've compiled three relevant items you should look at:
- Risks: Every company has them, and we've spotted 1 warning sign for LY you should know about.
- Future Earnings: How does 4689'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 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!
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.
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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.
About TSE:4689
LY
Engages in the online advertising and e-commerce businesses in Japan.