Are Investors Undervaluing LOIVE Co.,Ltd. (TSE:352A) By 44%?

Key Insights

• The projected fair value for LOIVELtd is JP¥1,612 based on 2 Stage Free Cash Flow to Equity
• LOIVELtd is estimated to be 44% undervalued based on current share price of JP¥900
• Peers of LOIVELtd are currently trading on average at a 172% premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of LOIVE Co.,Ltd. (TSE:352A) as an investment opportunity by taking the expected future cash flows and discounting them to today's 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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The Model

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 begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (¥, Millions)	JP¥1.21b	JP¥1.27b	JP¥1.32b	JP¥1.36b	JP¥1.39b	JP¥1.41b	JP¥1.43b	JP¥1.45b	JP¥1.46b	JP¥1.48b
Growth Rate Estimate Source	Est @ 7.22%	Est @ 5.24%	Est @ 3.84%	Est @ 2.87%	Est @ 2.19%	Est @ 1.71%	Est @ 1.38%	Est @ 1.15%	Est @ 0.98%	Est @ 0.87%
Present Value (¥, Millions) Discounted @ 7.3%	JP¥1.1k	JP¥1.1k	JP¥1.1k	JP¥1.0k	JP¥976	JP¥925	JP¥874	JP¥824	JP¥775	JP¥729

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥9.4b

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 7.3%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = JP¥1.5b× (1 + 0.6%) ÷ (7.3%– 0.6%) = JP¥22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥22b÷ ( 1 + 7.3%)¹⁰= JP¥11b

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¥20b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of JP¥900, the company appears quite good value at a 44% discount to where the stock price trades currently. 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

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 LOIVELtd 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 7.3%, which is based on a levered beta of 1.279. 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 LOIVELtd

SWOT Analysis for LOIVELtd

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. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 sitting below the intrinsic value? For LOIVELtd, we've put together three pertinent aspects you should further research:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with LOIVELtd , and understanding these should be part of your investment process.
2. Future Earnings: How does 352A'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.