Calculating The Fair Value Of Otsuka Holdings Co., Ltd. (TSE:4578)

Key Insights

• The projected fair value for Otsuka Holdings is JP¥9,871 based on 2 Stage Free Cash Flow to Equity
• Otsuka Holdings' JP¥8,063 share price indicates it is trading at similar levels as its fair value estimate
• Analyst price target for 4578 is JP¥9,268 which is 6.1% below our fair value estimate

Does the January share price for Otsuka Holdings Co., Ltd. (TSE:4578) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Otsuka Holdings

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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¥262.9b	JP¥244.9b	JP¥254.7b	JP¥276.4b	JP¥247.9b	JP¥230.8b	JP¥219.9b	JP¥212.8b	JP¥208.2b	JP¥205.2b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x3	Analyst x3	Analyst x1	Est @ -6.91%	Est @ -4.74%	Est @ -3.23%	Est @ -2.17%	Est @ -1.42%
Present Value (¥, Millions) Discounted @ 4.3%	JP¥252.1k	JP¥225.1k	JP¥224.5k	JP¥233.6k	JP¥200.9k	JP¥179.3k	JP¥163.8k	JP¥152.0k	JP¥142.6k	JP¥134.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥1.9t

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. 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 4.3%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥205b× (1 + 0.3%) ÷ (4.3%– 0.3%) = JP¥5.2t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥5.2t÷ ( 1 + 4.3%)¹⁰= JP¥3.4t

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¥5.3t. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥8.1k, the company appears about fair value at a 18% 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Otsuka Holdings 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 4.3%, which is based on a levered beta of 0.800. 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 Otsuka Holdings

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Otsuka Holdings, we've put together three further elements you should consider:

1. Risks: Take risks, for example - Otsuka Holdings has 1 warning sign we think you should be aware of.
2. Future Earnings: How does 4578'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.