Calculating the intrinsic value of Fujikura Ltd. (TSE:5803)

Key findings

• Using the 2-step free cash flow to equity, the estimated fair value of Fujikura is JP¥2,884.
• Fujikura’s share price of JP¥3,070 suggests that the share price is at a similar level to the estimated fair value
• The analyst price target for 5803 is JP¥2,971, which is 3.0% above our fair value estimate.

Today we’ll go through one way to estimate the intrinsic value of Fujikura Ltd. (TSE:5803) by taking the company’s forecasted future cash flows and discounting them to today’s value. One way to do this is by applying the discounted cash flow (DCF) model. Don’t be put off by the technical jargon, the math behind it is actually quite simple.

We would like to point out that there are many ways to value a company and that each method, like the DCF, has advantages and disadvantages in certain scenarios. If you still have questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Fujikura

Is Fujikura fairly valued?

We use the 2-stage growth model, which simply means that we consider two stages of company growth. In the early stage, the company might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to estimate the next ten years’ worth of cash flows. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, we discount the value of these future cash flows to their estimated value in today’s dollars:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 321 billion JPY

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value that takes into account all future cash flows after the first period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 0.2%. We discount the terminal cash flows to today’s value at a cost of equity of 7.0%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = JP¥64 billion × (1 + 0.2%) ÷ (7.0% – 0.2%) = JP¥935 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 935 billion JPY ÷ ( 1 + 7.0 %)¹⁰= 474 billion JPY

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is JP¥795 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥3.1k, the company seems to be around fair value at the time of writing. However, keep in mind that this is only an approximate valuation and as with any complex formula, where garbage comes in, garbage comes out.

Important assumptions

The above calculation relies heavily on two assumptions. The first is the discount rate and the other is the cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we are considering Fujikura 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 takes debt into account. In this calculation, we used 7.0%, which is based on a leveraged beta of 1.212. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Fujikura

Looking ahead:

While a company’s valuation is important, ideally it shouldn’t be the only analysis you look at for a company. DCF models are not the be-all and end-all of investment valuation. Rather, they should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued.” For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. With Fujikura, there are three additional elements you should consider:

1. Risks: You should be aware 2 warning signs for Fujikura we uncovered before considering investing in the company.
2. Future income: How does 5803’s growth rate compare to its competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. Other high-quality alternatives: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!

PS. Simply Wall St updates its DCF calculation for each Japanese stock daily, so if you want to find out the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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