Does This Valuation Of SHIMAMURA Co., Ltd. (TSE:8227) Imply Investors Are Overpaying?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, SHIMAMURA fair value estimate is JP¥8,990
• Current share price of JP¥11,005 suggests SHIMAMURA is potentially 22% overvalued
• The JP¥10,325 analyst price target for 8227 is 15% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of SHIMAMURA Co., Ltd. (TSE:8227) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

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The Calculation

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (¥, Millions)	JP¥38.0b	JP¥31.2b	JP¥39.4b	JP¥39.3b	JP¥39.3b	JP¥39.4b	JP¥39.5b	JP¥39.6b	JP¥39.8b	JP¥40.0b
Growth Rate Estimate Source	Analyst x2	Analyst x4	Analyst x4	Est @ -0.23%	Est @ 0.02%	Est @ 0.19%	Est @ 0.31%	Est @ 0.40%	Est @ 0.46%	Est @ 0.50%
Present Value (¥, Millions) Discounted @ 6.3%	JP¥35.7k	JP¥27.6k	JP¥32.8k	JP¥30.8k	JP¥28.9k	JP¥27.3k	JP¥25.7k	JP¥24.3k	JP¥23.0k	JP¥21.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥278b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 0.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.3%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = JP¥40b× (1 + 0.6%) ÷ (6.3%– 0.6%) = JP¥706b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥706b÷ ( 1 + 6.3%)¹⁰= JP¥383b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is JP¥661b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥11k, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

Important 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 SHIMAMURA 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 6.3%, which is based on a levered beta of 1.086. 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 SHIMAMURA

SWOT Analysis for SHIMAMURA

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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. What is the reason for the share price exceeding the intrinsic value? For SHIMAMURA, we've put together three important items you should further examine:

1. Risks: As an example, we've found 1 warning sign for SHIMAMURA that you need to consider before investing here.
2. Future Earnings: How does 8227'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.

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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.