A Look At The Fair Value Of LAC Co., Ltd. (TYO:3857)

In this article we are going to estimate the intrinsic value of LAC Co., Ltd. (TYO:3857) 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for LAC

Step by step through the calculation

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 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2020	2021	2022	2023	2024	2025	2026	2027	2028	2029
Levered FCF (¥, Millions)	JP¥1.36b	JP¥1.51b	JP¥1.65b	JP¥1.80b	JP¥1.95b	JP¥2.10b	JP¥2.17b	JP¥2.22b	JP¥2.26b	JP¥2.29b
Growth Rate Estimate Source	Est @ 4.79%	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ 3.37%	Est @ 2.37%	Est @ 1.68%	Est @ 1.19%
Present Value (¥, Millions) Discounted @ 7.8%	JP¥1.3k	JP¥1.3k	JP¥1.3k	JP¥1.3k	JP¥1.3k	JP¥1.3k	JP¥1.3k	JP¥1.2k	JP¥1.1k	JP¥1.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥13b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.05%) 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 7.8%.

Terminal Value (TV)= FCF₂₀₂₉ × (1 + g) ÷ (r – g) = JP¥2.3b× (1 + 0.05%) ÷ (7.8%– 0.05%) = JP¥29b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥29b÷ ( 1 + 7.8%)¹⁰= JP¥14b

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¥26b. 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¥1.2k, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 LAC 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 7.8%, which is based on a levered beta of 1.063. 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.

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. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For LAC, there are three fundamental factors you should explore:

1. Risks: You should be aware of the 2 warning signs for LAC we've uncovered before considering an investment in the company.
2. Future Earnings: How does 3857'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 JASDAQ 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. 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.
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