Is MTG Co., Ltd. (TSE:7806) Trading At A 34% Discount?
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, MTG fair value estimate is JP¥7,438
- MTG is estimated to be 34% undervalued based on current share price of JP¥4,940
- The JP¥6,400 analyst price target for 7806 is 14% less than our estimate of fair value
Does the January share price for MTG Co., Ltd. (TSE:7806) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
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.
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 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 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¥1.24b | JP¥4.12b | JP¥8.38b | JP¥12.5b | JP¥13.7b | JP¥14.5b | JP¥15.2b | JP¥15.7b | JP¥16.1b | JP¥16.4b |
| Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x2 | Analyst x1 | Analyst x1 | Est @ 6.08% | Est @ 4.44% | Est @ 3.29% | Est @ 2.48% | Est @ 1.92% |
| Present Value (¥, Millions) Discounted @ 5.3% | JP¥1.2k | JP¥3.7k | JP¥7.2k | JP¥10.2k | JP¥10.6k | JP¥10.7k | JP¥10.6k | JP¥10.4k | JP¥10.1k | JP¥9.8k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥84b
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 5.3%.
Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = JP¥16b× (1 + 0.6%) ÷ (5.3%– 0.6%) = JP¥349b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= JP¥349b÷ ( 1 + 5.3%)10= JP¥208b
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¥292b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥4.9k, the company appears quite good value at a 34% 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.
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 MTG 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 5.3%, which is based on a levered beta of 0.898. 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 MTG
SWOT Analysis for MTG
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Dividend is low compared to the top 25% of dividend payers in the Personal Products market.
- Annual earnings are forecast to grow faster than the Japanese market.
- Good value based on P/E ratio and estimated fair value.
- Revenue is forecast to grow slower than 20% per year.
Looking Ahead:
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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For MTG, we've put together three essential aspects you should further research:
- Risks: Be aware that MTG is showing 2 warning signs in our investment analysis , you should know about...
- Future Earnings: How does 7806'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. 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.