Estimating The Fair Value Of halmek holdings Co.,Ltd. (TSE:7119)

Key Insights

• halmek holdingsLtd's estimated fair value is JP¥959 based on 2 Stage Free Cash Flow to Equity
• Current share price of JP¥985 suggests halmek holdingsLtd is potentially trading close to its fair value
• halmek holdingsLtd's peers are currently trading at a discount of 8.3% on average

Today we will run through one way of estimating the intrinsic value of halmek holdings Co.,Ltd. (TSE:7119) by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

View our latest analysis for halmek holdingsLtd

What's The Estimated Valuation?

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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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¥763.2m	JP¥672.4m	JP¥617.1m	JP¥582.1m	JP¥559.5m	JP¥544.8m	JP¥535.4m	JP¥529.3m	JP¥525.6m	JP¥523.6m
Growth Rate Estimate Source	Est @ -17.13%	Est @ -11.90%	Est @ -8.23%	Est @ -5.67%	Est @ -3.88%	Est @ -2.62%	Est @ -1.74%	Est @ -1.13%	Est @ -0.70%	Est @ -0.39%
Present Value (¥, Millions) Discounted @ 5.5%	JP¥724	JP¥605	JP¥526	JP¥471	JP¥429	JP¥396	JP¥369	JP¥346	JP¥326	JP¥308

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥4.5b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 5.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥524m× (1 + 0.3%) ÷ (5.5%– 0.3%) = JP¥10b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥10b÷ ( 1 + 5.5%)¹⁰= JP¥6.0b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is JP¥10b. 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¥985, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

Now 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 halmek holdingsLtd 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 5.5%, which is based on a levered beta of 1.034. 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.

Looking Ahead:

Although the valuation of a company is important, 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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For halmek holdingsLtd, we've compiled three fundamental elements you should assess:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with halmek holdingsLtd , and understanding them should be part of your investment process.
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.