Stock Analysis

Calculating The Fair Value Of ABC-Mart,Inc. (TSE:2670)

Key Insights

• ABC-MartInc's estimated fair value is JP¥2,870 based on 2 Stage Free Cash Flow to Equity
• With JP¥2,894 share price, ABC-MartInc appears to be trading close to its estimated fair value
• Our fair value estimate is 4.0% lower than ABC-MartInc's analyst price target of JP¥2,991

Does the March share price for ABC-Mart,Inc. (TSE:2670) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 ABC-MartInc

The Method

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (¥, Millions) JP¥35.7b JP¥32.8b JP¥35.8b JP¥39.2b JP¥40.5b JP¥41.4b JP¥42.0b JP¥42.5b JP¥42.8b JP¥43.1b Growth Rate Estimate Source Analyst x2 Analyst x4 Analyst x4 Analyst x1 Analyst x1 Est @ 2.14% Est @ 1.55% Est @ 1.13% Est @ 0.84% Est @ 0.64% Present Value (¥, Millions) Discounted @ 5.9% JP¥33.7k JP¥29.3k JP¥30.1k JP¥31.1k JP¥30.4k JP¥29.3k JP¥28.1k JP¥26.8k JP¥25.5k JP¥24.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥289b

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 5.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = JP¥43b× (1 + 0.2%) ÷ (5.9%– 0.2%) = JP¥750b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥750b÷ ( 1 + 5.9%)10= JP¥422b

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¥711b. 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¥2.9k, the company appears around fair value at the time of writing. 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. 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 ABC-MartInc 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 5.9%, which is based on a levered beta of 1.023. 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 ABC-MartInc

Strength
• Earnings growth over the past year exceeded the industry.
• Debt is not viewed as a risk.
Weakness
• Dividend is low compared to the top 25% of dividend payers in the Specialty Retail market.
• Expensive based on P/E ratio and estimated fair value.
Opportunity
• Annual revenue is forecast to grow faster than the Japanese market.
Threat
• Dividends are not covered by cash flow.
• Annual earnings are forecast to grow slower than the Japanese market.

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For ABC-MartInc, there are three important elements you should consider:

1. Risks: Case in point, we've spotted 1 warning sign for ABC-MartInc you should be aware of.
2. Future Earnings: How does 2670'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.

Valuation is complex, but we're helping make it simple.

Find out whether ABC-MartInc is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.