Estimating The Fair Value Of Kohoku Kogyo CO.,LTD. (TSE:6524)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Kohoku KogyoLTD fair value estimate is JP¥3,681
• With JP¥3,345 share price, Kohoku KogyoLTD appears to be trading close to its estimated fair value
• Our fair value estimate is 6.7% higher than Kohoku KogyoLTD's analyst price target of JP¥3,450

Today we will run through one way of estimating the intrinsic value of Kohoku Kogyo CO.,LTD. (TSE:6524) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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.

View our latest analysis for Kohoku KogyoLTD

The Model

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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥1.76b	JP¥2.48b	JP¥4.07b	JP¥4.68b	JP¥5.10b	JP¥5.43b	JP¥5.68b	JP¥5.86b	JP¥6.00b	JP¥6.11b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Analyst x1	Est @ 9.06%	Est @ 6.42%	Est @ 4.57%	Est @ 3.28%	Est @ 2.37%	Est @ 1.74%
Present Value (¥, Millions) Discounted @ 5.6%	JP¥1.7k	JP¥2.2k	JP¥3.4k	JP¥3.8k	JP¥3.9k	JP¥3.9k	JP¥3.9k	JP¥3.8k	JP¥3.7k	JP¥3.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥34b

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 0.3%. We discount the terminal cash flows to today's value at a cost of equity of 5.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥6.1b× (1 + 0.3%) ÷ (5.6%– 0.3%) = JP¥114b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥114b÷ ( 1 + 5.6%)¹⁰= JP¥66b

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¥99b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥3.3k, the company appears about fair value at a 9.1% 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Kohoku KogyoLTD 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 5.6%, which is based on a levered beta of 1.081. 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 Kohoku KogyoLTD

Moving On:

Although the valuation of a company is important, 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Kohoku KogyoLTD, we've put together three essential aspects you should consider:

1. Risks: We feel that you should assess the 1 warning sign for Kohoku KogyoLTD we've flagged before making an investment in the company.
2. Future Earnings: How does 6524'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.