Is Nippon Sanso Holdings Corporation (TSE:4091) Trading At A 25% Discount?

Key Insights

• Nippon Sanso Holdings' estimated fair value is JP¥6,083 based on 2 Stage Free Cash Flow to Equity
• Nippon Sanso Holdings' JP¥4,564 share price signals that it might be 25% undervalued
• The JP¥5,000 analyst price target for 4091 is 18% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Nippon Sanso Holdings Corporation (TSE:4091) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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The Method

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.

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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥88.6b	JP¥97.5b	JP¥102.2b	JP¥119.9b	JP¥137.9b	JP¥149.8b	JP¥158.9b	JP¥165.9b	JP¥171.2b	JP¥175.3b
Growth Rate Estimate Source	Analyst x4	Analyst x3	Analyst x4	Analyst x3	Analyst x2	Est @ 8.60%	Est @ 6.13%	Est @ 4.40%	Est @ 3.19%	Est @ 2.35%
Present Value (¥, Millions) Discounted @ 6.2%	JP¥83.4k	JP¥86.5k	JP¥85.5k	JP¥94.4k	JP¥102.3k	JP¥104.6k	JP¥104.6k	JP¥102.9k	JP¥100.0k	JP¥96.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥961b

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 (0.4%) 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 6.2%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥175b× (1 + 0.4%) ÷ (6.2%– 0.4%) = JP¥3.0t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥3.0t÷ ( 1 + 6.2%)¹⁰= JP¥1.7t

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¥2.6t. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥4.6k, the company appears a touch undervalued at a 25% 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.

Important 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 Nippon Sanso Holdings 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 6.2%, which is based on a levered beta of 1.098. 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.

See our latest analysis for Nippon Sanso Holdings

SWOT Analysis for Nippon Sanso Holdings

Moving On:

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. 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. What is the reason for the share price sitting below the intrinsic value? For Nippon Sanso Holdings, we've compiled three essential elements you should consider:

1. Risks: For instance, we've identified 1 warning sign for Nippon Sanso Holdings that you should be aware of.
2. Future Earnings: How does 4091'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 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.