Does This Valuation Of Toei Animation Co.,Ltd. (TSE:4816) Imply Investors Are Overpaying?

Key Insights

• Toei AnimationLtd's estimated fair value is JP¥2,070 based on 2 Stage Free Cash Flow to Equity
• Current share price of JP¥2,658 suggests Toei AnimationLtd is potentially 28% overvalued
• Our fair value estimate is 45% lower than Toei AnimationLtd's analyst price target of JP¥3,787

In this article we are going to estimate the intrinsic value of Toei Animation Co.,Ltd. (TSE:4816) by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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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 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (¥, Millions)	JP¥20.7b	JP¥20.6b	JP¥24.9b	JP¥25.6b	JP¥27.1b	JP¥28.2b	JP¥29.1b	JP¥29.7b	JP¥30.3b	JP¥30.7b
Growth Rate Estimate Source	Analyst x3	Analyst x4	Analyst x4	Analyst x2	Analyst x2	Est @ 4.01%	Est @ 2.99%	Est @ 2.27%	Est @ 1.77%	Est @ 1.42%
Present Value (¥, Millions) Discounted @ 7.1%	JP¥19.3k	JP¥18.0k	JP¥20.3k	JP¥19.5k	JP¥19.3k	JP¥18.7k	JP¥18.0k	JP¥17.2k	JP¥16.4k	JP¥15.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥182b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.6%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = JP¥31b× (1 + 0.6%) ÷ (7.1%– 0.6%) = JP¥477b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥477b÷ ( 1 + 7.1%)¹⁰= JP¥241b

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¥423b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of JP¥2.7k, the company appears slightly overvalued at the time of writing. 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

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 Toei AnimationLtd 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 7.1%, which is based on a levered beta of 1.233. 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 Toei AnimationLtd

SWOT Analysis for Toei AnimationLtd

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. Why is the intrinsic value lower than the current share price? For Toei AnimationLtd, there are three essential elements you should look at:

1. Financial Health: Does 4816 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does 4816'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. 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.