Is Kumagai Gumi Co.,Ltd. (TSE:1861) Worth JP¥1.6k Based On Its Intrinsic Value?
Key Insights
- Kumagai GumiLtd's estimated fair value is JP¥1,266 based on 2 Stage Free Cash Flow to Equity
- Kumagai GumiLtd's JP¥1,565 share price signals that it might be 24% overvalued
- Analyst price target for 1861 is JP¥1,630, which is 29% above our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Kumagai Gumi Co.,Ltd. (TSE:1861) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
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. 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.
Crunching The Numbers
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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
| 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | 2035 | |
| Levered FCF (¥, Millions) | JP¥15.9b | JP¥12.8b | JP¥13.5b | JP¥13.9b | JP¥14.3b | JP¥14.6b | JP¥14.8b | JP¥15.0b | JP¥15.2b | JP¥15.3b |
| Growth Rate Estimate Source | Analyst x1 | Analyst x3 | Analyst x2 | Est @ 3.53% | Est @ 2.65% | Est @ 2.04% | Est @ 1.60% | Est @ 1.30% | Est @ 1.09% | Est @ 0.94% |
| Present Value (¥, Millions) Discounted @ 7.2% | JP¥14.8k | JP¥11.1k | JP¥10.9k | JP¥10.5k | JP¥10.1k | JP¥9.6k | JP¥9.1k | JP¥8.6k | JP¥8.1k | JP¥7.7k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥101b
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 7.2%.
Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = JP¥15b× (1 + 0.6%) ÷ (7.2%– 0.6%) = JP¥234b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥234b÷ ( 1 + 7.2%)10= JP¥117b
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¥217b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥1.6k, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Kumagai GumiLtd 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 7.2%, which is based on a levered beta of 1.255. 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 Kumagai GumiLtd
SWOT Analysis for Kumagai GumiLtd
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Dividend is low compared to the top 25% of dividend payers in the Construction market.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow faster than the Japanese market.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company has no free cash flows.
- Annual revenue is forecast to grow slower than the Japanese market.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Kumagai GumiLtd, we've put together three pertinent items you should further examine:
- Risks: Be aware that Kumagai GumiLtd is showing 1 warning sign in our investment analysis , you should know about...
- Future Earnings: How does 1861'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.
- 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.