Is There An Opportunity With Sawai Group Holdings Co., Ltd.'s (TSE:4887) 41% Undervaluation?

Key Insights

• The projected fair value for Sawai Group Holdings is JP¥10,341 based on 2 Stage Free Cash Flow to Equity
• Current share price of JP¥6,140 suggests Sawai Group Holdings is potentially 41% undervalued
• Our fair value estimate is 53% higher than Sawai Group Holdings' analyst price target of JP¥6,780

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Sawai Group Holdings Co., Ltd. (TSE:4887) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Sawai Group Holdings

The Calculation

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 begin with, we have to get estimates of 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (¥, Millions)	JP¥6.20b	JP¥22.3b	JP¥13.6b	JP¥13.9b	JP¥14.9b	JP¥18.7b	JP¥20.1b	JP¥21.2b	JP¥22.0b	JP¥22.6b
Growth Rate Estimate Source	Analyst x5	Analyst x5	Analyst x5	Analyst x4	Analyst x4	Analyst x2	Est @ 7.60%	Est @ 5.37%	Est @ 3.81%	Est @ 2.71%
Present Value (¥, Millions) Discounted @ 4.7%	JP¥5.9k	JP¥20.3k	JP¥11.8k	JP¥11.6k	JP¥11.9k	JP¥14.2k	JP¥14.6k	JP¥14.7k	JP¥14.6k	JP¥14.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥134b

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 (0.2%) 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 4.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = JP¥23b× (1 + 0.2%) ÷ (4.7%– 0.2%) = JP¥503b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥503b÷ ( 1 + 4.7%)¹⁰= JP¥319b

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¥453b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of JP¥6.1k, the company appears quite good value at a 41% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

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. 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 Sawai Group 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 4.7%, 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 Sawai Group Holdings

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for 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. Can we work out why the company is trading at a discount to intrinsic value? For Sawai Group Holdings, we've compiled three additional factors you should assess:

1. Risks: As an example, we've found 1 warning sign for Sawai Group Holdings that you need to consider before investing here.
2. Future Earnings: How does 4887'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. 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.