An Intrinsic Calculation For Nippon Sanso Holdings Corporation (TSE:4091) Suggests It's 29% Undervalued

Key Insights

• Nippon Sanso Holdings' estimated fair value is JP¥6,491 based on 2 Stage Free Cash Flow to Equity
• Current share price of JP¥4,640 suggests Nippon Sanso Holdings is potentially 29% undervalued
• Our fair value estimate is 23% higher than Nippon Sanso Holdings' analyst price target of JP¥5,286

How far off is Nippon Sanso Holdings Corporation (TSE:4091) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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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Step By Step Through The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate 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) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (¥, Millions)	JP¥66.3b	JP¥85.0b	JP¥99.6b	JP¥126.0b	JP¥142.9b	JP¥154.8b	JP¥164.1b	JP¥171.2b	JP¥176.8b	JP¥181.1b
Growth Rate Estimate Source	Analyst x2	Analyst x3	Analyst x3	Analyst x2	Analyst x2	Est @ 8.31%	Est @ 6.00%	Est @ 4.38%	Est @ 3.24%	Est @ 2.45%
Present Value (¥, Millions) Discounted @ 6.1%	JP¥62.5k	JP¥75.5k	JP¥83.5k	JP¥99.5k	JP¥106.5k	JP¥108.7k	JP¥108.7k	JP¥107.0k	JP¥104.1k	JP¥100.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥957b

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 (0.6%) 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 6.1%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = JP¥181b× (1 + 0.6%) ÷ (6.1%– 0.6%) = JP¥3.3t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥3.3t÷ ( 1 + 6.1%)¹⁰= JP¥1.9t

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¥2.8t. The last step is to then 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 29% 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

We would point out that 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 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 6.1%, which is based on a levered beta of 1.040. 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.

View our latest analysis for Nippon Sanso Holdings

SWOT Analysis for Nippon Sanso Holdings

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Nippon Sanso Holdings, we've compiled three essential factors you should further examine:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Nippon Sanso Holdings .
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 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.