Estimating The Fair Value Of Workman Co.,Ltd. (TSE:7564)

Key Insights

• The projected fair value for WorkmanLtd is JP¥3,885 based on 2 Stage Free Cash Flow to Equity
• With JP¥3,740 share price, WorkmanLtd appears to be trading close to its estimated fair value
• Analyst price target for 7564 is JP¥4,223, which is 8.7% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Workman Co.,Ltd. (TSE:7564) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 WorkmanLtd

Is WorkmanLtd Fairly Valued?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥13.4b	JP¥14.6b	JP¥15.3b	JP¥16.6b	JP¥17.6b	JP¥18.2b	JP¥18.7b	JP¥19.1b	JP¥19.4b	JP¥19.6b
Growth Rate Estimate Source	Analyst x3	Analyst x4	Analyst x3	Analyst x2	Analyst x2	Est @ 3.85%	Est @ 2.76%	Est @ 1.99%	Est @ 1.45%	Est @ 1.08%
Present Value (¥, Millions) Discounted @ 5.9%	JP¥12.6k	JP¥13.0k	JP¥12.8k	JP¥13.1k	JP¥13.2k	JP¥12.9k	JP¥12.5k	JP¥12.0k	JP¥11.5k	JP¥11.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥125b

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 0.2%. We discount the terminal cash flows to today's value at a cost of equity of 5.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥20b× (1 + 0.2%) ÷ (5.9%– 0.2%) = JP¥342b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥342b÷ ( 1 + 5.9%)¹⁰= JP¥192b

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¥317b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥3.7k, the company appears about fair value at a 3.7% 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.

The 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 WorkmanLtd 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 1.019. 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 WorkmanLtd

Looking Ahead:

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. 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 WorkmanLtd, there are three pertinent elements you should consider:

1. Financial Health: Does 7564 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does 7564'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com