Estimating The Fair Value Of Shibaura Mechatronics Corporation (TSE:6590)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Shibaura Mechatronics fair value estimate is JP¥24,126
• With JP¥20,470 share price, Shibaura Mechatronics appears to be trading close to its estimated fair value
• The JP¥21,667 analyst price target for 6590 is 10% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Shibaura Mechatronics Corporation (TSE:6590) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

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. 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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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 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¥7.04b	JP¥10.0b	JP¥14.5b	JP¥19.1b	JP¥23.4b	JP¥27.1b	JP¥30.1b	JP¥32.5b	JP¥34.4b	JP¥35.9b
Growth Rate Estimate Source	Analyst x1	Analyst x2	Est @ 44.87%	Est @ 31.59%	Est @ 22.29%	Est @ 15.78%	Est @ 11.23%	Est @ 8.04%	Est @ 5.81%	Est @ 4.25%
Present Value (¥, Millions) Discounted @ 9.0%	JP¥6.5k	JP¥8.4k	JP¥11.2k	JP¥13.5k	JP¥15.2k	JP¥16.1k	JP¥16.5k	JP¥16.3k	JP¥15.9k	JP¥15.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥135b

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 9.0%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = JP¥36b× (1 + 0.6%) ÷ (9.0%– 0.6%) = JP¥430b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥430b÷ ( 1 + 9.0%)¹⁰= JP¥182b

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¥317b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥20k, the company appears about fair value at a 15% 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Shibaura Mechatronics 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 9.0%, which is based on a levered beta of 1.598. 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 Shibaura Mechatronics

SWOT Analysis for Shibaura Mechatronics

Next Steps:

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. 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 Shibaura Mechatronics, we've compiled three pertinent aspects you should consider:

1. Risks: Case in point, we've spotted 2 warning signs for Shibaura Mechatronics you should be aware of.
2. Future Earnings: How does 6590'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.