Key findings
- Using the 2-step free cash flow to equity, the estimated fair value of PeptiDream is JP¥4,180.
- The current share price of JP¥2,625 suggests that PeptiDream may be undervalued by 37%
- The analyst price target of 3,367 JP¥ for 4587 is 19% below our fair value estimate
Today we’ll run through a valuation method that can be used to estimate the attractiveness of PeptiDream Inc. (TSE:4587) as an investment opportunity. To do this, we’ll project the future cash flows and discount them to today’s value. To do this, we’ll use the Discounted Cash Flow (DCF) model. Before you think you can’t understand it, just keep reading! It’s actually a lot less complex than you think.
Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. If you want to learn more about intrinsic value, you should take a look at Simply Wall St’s analysis model.
Check out our latest analysis for PeptiDream
The calculation
We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, 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 that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.
A DCF is all about the idea that a dollar in the future is worth less than a dollar today. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimation of free cash flow (FCF) over 10 years
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Leveraged FCF (¥, million) | 12.7 billion JPY | 15.2 billion JPY | 16.7 billion JPY | 20.6 billion JPY | 22.8 billion JPY | 24.5 billion JPY | 25.9 billion JPY | 26.9 billion JPY | 27.6 billion JPY | 28.2 billion JPY |
Source of growth rate estimate | Analyst x4 | Analyst x4 | Analyst x3 | Analyst x3 | Estimated at 10.87% | Estimated at 7.69% | Estimated at 5.46% | Estimated at 3.90% | Estimated at 2.81% | Estimated at 2.04% |
Present value (¥, million) discounted at 4.9% | 12.1k JPY | 13.8 thousand JPY | 14.5 thousand JPY | 17,000 JPY | 17.9 thousand JPY | 18.4 thousand JPY | 18.5 thousand JPY | 18.3 thousand JPY | 17.9 thousand JPY | 17.5 thousand JPY |
(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 166 billion JPY
The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 0.3%. We discount the terminal cash flows to today’s value at a cost of equity of 4.9%.
Final value (TV)= FCF_{2034} × (1 + g) ÷ (r – g) = 28b JP¥ × (1 + 0.3%) ÷ (4.9% – 0.3%) = 607b JP¥
Present value of terminal value (PVTV)= TV / (1 + r)^{10}= 607 billion JPY ÷ (1 + 4.9%)^{10}= 376 billion JPY
The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is JP¥542 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥2.6k, the company seems to offer quite good value for money at a 37% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s better to consider this as a rough estimate that is not accurate to the last cent.
The assumptions
We would like to point out that the main 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 repeating the calculations yourself and playing around with them. The DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we consider PeptiDream as potential shareholders, the cost of equity is used as the discount rate and not the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation, we used 4.9%, which is based on a leveraged beta of 0.935. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.
SWOT analysis for PeptiDream
- Last year’s profit growth exceeded the industry average.
- The debts are well covered by the income.
- No major weaknesses were identified for 4587.
- Good value based on P/E and estimated fair value.
- The debts cannot be adequately covered by the operating cash flow.
- A decline in annual income is forecast for the next three years.
Outlook:
While a company’s valuation is important, ideally it shouldn’t be the only analysis you look at for a company. It’s not possible to get a foolproof valuation using a DCF model. Rather, it should be viewed as a guide to “what assumptions need to hold 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 significantly, the outcome can look very different. Why is the intrinsic value higher than the current share price? For PeptiDream, we’ve compiled three additional factors you should examine in more detail:
- Risks: Take risks, for example – PeptiDream has 3 warning signs (and 2 that can’t be ignored) that we think you should know about.
- Future income: How does 4587’s growth rate compare to its competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
- 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 you might be missing out on!
PS. Simply Wall St updates its DCF calculation for each Japanese stock daily, so if you want to find out the intrinsic value of another stock, just search here.
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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.