Estimating The Fair Value Of Resonac Holdings Corporation (TSE:4004)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Resonac Holdings fair value estimate is JP¥7,885
• Resonac Holdings' JP¥6,751 share price indicates it is trading at similar levels as its fair value estimate
• The JP¥6,659 analyst price target for 4004 is 16% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Resonac Holdings Corporation (TSE:4004) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Step By Step Through 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (¥, Millions)	JP¥52.0b	JP¥83.6b	JP¥62.6b	JP¥81.4b	JP¥86.9b	JP¥91.3b	JP¥94.7b	JP¥97.3b	JP¥99.3b	JP¥101.0b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x2	Analyst x2	Est @ 6.88%	Est @ 5.00%	Est @ 3.68%	Est @ 2.75%	Est @ 2.11%	Est @ 1.66%
Present Value (¥, Millions) Discounted @ 6.8%	JP¥48.7k	JP¥73.2k	JP¥51.3k	JP¥62.5k	JP¥62.5k	JP¥61.4k	JP¥59.6k	JP¥57.4k	JP¥54.8k	JP¥52.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥584b

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 6.8%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = JP¥101b× (1 + 0.6%) ÷ (6.8%– 0.6%) = JP¥1.6t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥1.6t÷ ( 1 + 6.8%)¹⁰= JP¥843b

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¥1.4t. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥6.8k, the company appears about fair value at a 14% 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Resonac 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 6.8%, which is based on a levered beta of 1.186. 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 Resonac Holdings

SWOT Analysis for Resonac Holdings

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for 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. For Resonac Holdings, we've put together three important factors you should assess:

1. Risks: For instance, we've identified 2 warning signs for Resonac Holdings (1 is significant) you should be aware of.
2. Future Earnings: How does 4004'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.