A Look At The Fair Value Of Hamamatsu Photonics K.K. (TSE:6965)

Simply Wall St · 11/25 23:34

Key Insights

  • The projected fair value for Hamamatsu Photonics K.K is JP¥1,852 based on 2 Stage Free Cash Flow to Equity
  • With JP¥1,791 share price, Hamamatsu Photonics K.K appears to be trading close to its estimated fair value
  • The JP¥2,571 analyst price target for 6965 is 39% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Hamamatsu Photonics K.K. (TSE:6965) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Hamamatsu Photonics K.K

The Model

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 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¥17.7b JP¥26.9b JP¥32.2b JP¥29.5b JP¥31.4b JP¥32.2b JP¥32.8b JP¥33.3b JP¥33.7b JP¥34.0b
Growth Rate Estimate Source Analyst x1 Analyst x3 Analyst x3 Analyst x3 Analyst x2 Est @ 2.60% Est @ 1.91% Est @ 1.43% Est @ 1.10% Est @ 0.86%
Present Value (¥, Millions) Discounted @ 5.8% JP¥16.8k JP¥24.0k JP¥27.2k JP¥23.5k JP¥23.6k JP¥22.9k JP¥22.1k JP¥21.1k JP¥20.2k JP¥19.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥221b

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 5.8%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = JP¥34b× (1 + 0.3%) ÷ (5.8%– 0.3%) = JP¥616b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥616b÷ ( 1 + 5.8%)10= JP¥349b

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¥570b. 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¥1.8k, the company appears about fair value at a 3.3% 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.

dcf
TSE:6965 Discounted Cash Flow November 25th 2024

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Hamamatsu Photonics K.K 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 5.8%, which is based on a levered beta of 1.111. 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 Hamamatsu Photonics K.K

Strength
  • Debt is not viewed as a risk.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Electronic market.
Opportunity
  • Annual earnings are forecast to grow faster than the Japanese market.
  • Current share price is below our estimate of fair value.
Threat
  • Dividends are not covered by cash flow.
  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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 Hamamatsu Photonics K.K, there are three relevant elements you should explore:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Hamamatsu Photonics K.K , and understanding them should be part of your investment process.
  2. Future Earnings: How does 6965'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. Simply Wall St updates its DCF calculation for every Japanese stock every day, so if you want to find the intrinsic value of any other stock just search here.