A Look At The Fair Value Of Core Concept Technologies Inc. (TSE:4371)

Key Insights

• Core Concept Technologies' estimated fair value is JP¥1,554 based on 2 Stage Free Cash Flow to Equity
• With JP¥1,558 share price, Core Concept Technologies appears to be trading close to its estimated fair value
• Industry average of 23% suggests Core Concept Technologies' peers are currently trading at a higher premium to fair value

In this article we are going to estimate the intrinsic value of Core Concept Technologies Inc. (TSE:4371) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Core Concept Technologies

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. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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¥1.17b	JP¥1.26b	JP¥1.34b	JP¥1.39b	JP¥1.43b	JP¥1.46b	JP¥1.49b	JP¥1.50b	JP¥1.52b	JP¥1.53b
Growth Rate Estimate Source	Est @ 11.55%	Est @ 8.17%	Est @ 5.79%	Est @ 4.13%	Est @ 2.97%	Est @ 2.16%	Est @ 1.59%	Est @ 1.19%	Est @ 0.91%	Est @ 0.72%
Present Value (¥, Millions) Discounted @ 5.7%	JP¥1.1k	JP¥1.1k	JP¥1.1k	JP¥1.1k	JP¥1.1k	JP¥1.0k	JP¥1.0k	JP¥965	JP¥922	JP¥878

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

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 5.7%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥1.5b× (1 + 0.3%) ÷ (5.7%– 0.3%) = JP¥28b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥28b÷ ( 1 + 5.7%)¹⁰= JP¥16b

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¥27b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥1.6k, 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

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 Core Concept Technologies 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 5.7%, which is based on a levered beta of 1.091. 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 is only one of many factors that you need to assess 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. For Core Concept Technologies, we've put together three pertinent aspects you should further research:

1. Risks: Case in point, we've spotted 1 warning sign for Core Concept Technologies you should be aware of.
2. Future Earnings: How does 4371'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.