A Look At The Fair Value Of CellSource Co., Ltd. (TSE:4880)

Key Insights

• The projected fair value for CellSource is JP¥1,410 based on 2 Stage Free Cash Flow to Equity
• With JP¥1,372 share price, CellSource appears to be trading close to its estimated fair value
• Our fair value estimate is 12% lower than CellSource's analyst price target of JP¥1,600

How far off is CellSource Co., Ltd. (TSE:4880) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for CellSource

The Model

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. 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.

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¥609.0m	JP¥833.0m	JP¥972.2m	JP¥1.09b	JP¥1.18b	JP¥1.25b	JP¥1.30b	JP¥1.34b	JP¥1.37b	JP¥1.39b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 16.71%	Est @ 11.78%	Est @ 8.32%	Est @ 5.90%	Est @ 4.21%	Est @ 3.02%	Est @ 2.20%	Est @ 1.61%
Present Value (¥, Millions) Discounted @ 4.8%	JP¥581	JP¥759	JP¥845	JP¥902	JP¥932	JP¥942	JP¥937	JP¥921	JP¥899	JP¥871

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥8.6b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 4.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥1.4b× (1 + 0.3%) ÷ (4.8%– 0.3%) = JP¥31b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥31b÷ ( 1 + 4.8%)¹⁰= JP¥19b

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¥28b. 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¥1.4k, the company appears about fair value at a 2.7% 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. 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 CellSource 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 4.8%, which is based on a levered beta of 0.907. 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 CellSource

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For CellSource, we've put together three important items you should further examine:

1. Risks: As an example, we've found 3 warning signs for CellSource (1 makes us a bit uncomfortable!) that you need to consider before investing here.
2. Future Earnings: How does 4880'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 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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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.