Industrials

In this briefing:

1. SoftBank Corp IPO Valuation: Bull/Bear Case DCF Scenarios
2. Discover HK Connect: Mainlanders Are Buying Shandong Gold, and Pharmaceuticals (2018-12-17)
3. Historical TOPIX Inclusions:  How Do They Do Around Inclusion Date?
4. Small Potatoes Nikkei 225 Changes on Christmas Day
5. SMC (6273 JP): Profits Start to Decline

1. SoftBank Corp IPO Valuation: Bull/Bear Case DCF Scenarios

Softbank Group (9984 JP) is set to raise JPY2.65 trillion ($23.5 billion) through the Softbank Corp (9434 JP) IPO, Japan’s biggest-ever IPO. However, SoftBank Corp’s IPO which is set for 19 December is oversubscribed by less than double, according to press reports. This level of oversubscription is well below blockbuster Japanese stock debuts such as Mercari Inc (4385 JP) and Recruit Holdings (6098 JP).

2. Discover HK Connect: Mainlanders Are Buying Shandong Gold, and Pharmaceuticals (2018-12-17)

In our Discover HK Connect series, we aim to help our investors understand the flow of southbound trades via the Hong Kong Connect, as analyzed by our proprietary data engine. We will discuss the stocks that experienced the most inflow and outflow by mainlanders in the past seven days.

We split the stocks eligible for the Hong Kong Connect trade into three groups: those with a market capitalization of above USD 5 billion, those with a market capitalization between USD 1 billion and USD 5 billion, and those with a market capitalization between USD 500 million and USD 1 billion.

3. Historical TOPIX Inclusions:  How Do They Do Around Inclusion Date?

There are seven stocks which were promoted/reassigned from TSE2, MOTHERS, and JASDAQ in November 2018 leading to the same seven stocks being included in TOPIX at the end of December. 

A couple are decently largecap. Most are smaller.

A good question to ask when looking at these stocks might be… What Really Happens Around TOPIX Inclusions?

Having traded them for much of the last 20yrs, I had my hypotheses, and had done studies over the years for my own purposes, but I had not done a study recently.  To check my personal hypotheses I tested 340+ TOPIX inclusions over the past five years. 

There are patterns to the history of trading these events which are worth a look. Some of the patterns are reasonably interesting.

4. Small Potatoes Nikkei 225 Changes on Christmas Day

Specialty steel maker Nisshin Steel (5413 JP) is slated to merge with parent company Nippon Steel & Sumitomo Metal (5401 JP) as of January 1, 2019. For that, Nisshin Steel will be delisted on December 26th (i.e. the last day of trading is the 25th) and that means the Nikkei Inc was obliged to choose a replacement to take Nisshin Steel’s place in the Nikkei 225 and other indices.

On December 11th, the Nikkei Inc announced Itoham Yonekyu Holdings Inc (2296 JP) would take Nisshin’s place in the Nikkei 500 Index, announced that Japan Post Holdings (6178 JP) would join the Nikkei 300 Index, and announced that Dic Corp (4631 JP) would replace Nisshin Steel in the Nikkei Stock Average, better known as the Nikkei 225.

The only one which matters is the Nikkei 225 (the other two have tiny tracking), and this is not a huge index trade as both Nisshin Steel and DIC are deemed 500 yen par value stocks.

This is an event one could “miss.”

And it will happen on Christmas Day, after a long weekend for Japan traders. 

5. SMC (6273 JP): Profits Start to Decline

SMC’s year-on-year profit comparisons have turned negative. In the three months to September (Q2 of FY Mar-19), gross profit was down 3.7% year-on-year, operating profit was down 8.8% and net profit was down 9.6%. Operating profit was down 15.1% from Q1. Sales were up only 0.4% year-on-year in Q2, compared with 29.0% growth a year earlier, and down 7.5% from Q1. Management responded by cutting full-year guidance, implicitly changing anticipated 2H operating profit growth from +3.0% to -9.3% year-on-year.

This has all been discounted. The share price dropped 43% from its 52-week and all-time high of ¥55,830 on January 18 to a 52-week low of ¥31,580 on October 28, then rebounded to ¥40,000 in early December. Last Friday, December 14, it closed at ¥34,840. 

What happens next? The share price trend suggests that because year-on-year profit comparisons have finally turned negative, it’s time to start anticipating recovery. But the  fundamentals indicate that profit comparisons are likely to remain very difficult and most probably negative for at least three more quarters. Management reports that semiconductor-related demand is down in all markets and that auto-related demand is down in the U.S. Auto sales are also declining in China. The length and depth of the downturn and the timing and strength of recovery are both unclear. Any positive news on the trade front should support the share price, but while trade friction aggravates the cyclical downturns in the semiconductor and auto industries, it is not their cause.

At ¥34,840, the shares are selling at 17.0x our EPS estimate for FY Mar-19 and 17.7x our estimate for FY Mar-20. These multiples compare with a 5-year historical range of 13.8x – 28.5x. Our projected EV/EBITDA multiples for the same two years are 8.7x and 8.1x, which compare with a 5-year historical range of 7.0x – 15.1x. This should help put a floor under the share price. Interestingly, Japan Analytics’ chart analysis indicates that SMC has never been seriously overbought (see chart below).

In this briefing:

1. SEAFCO (SEAFCO TB): Solid Backlog, Solid Profitability
2. Renesas: Visit Suggests Utilisation Rate Rebound Could Take Longer Than Sell-Side Expects
3. China Tower: Changing Our View to Positive. Low Cost Expansion Should Generate Better Returns
4. TRADE IDEA – Toyota Industries (6201 JP) Stub: Riding the Automation Wave
5. Doosan Bobcat – Negative on the North American Housing Market Turning Downwards

1. SEAFCO (SEAFCO TB): Solid Backlog, Solid Profitability

• Sales on an upward trend, good core profit return, and earnings on an upward trend relative to its sector
• Well-positioned to win some upcoming bids for public and private projects such as the MRT Purple Line, expressway, and high-speed train to boost earnings moving forward, net profit up by 134% in 3Q18 YoY
• Strong backlog of public and private projects amounting to around Bt3bn to help sustain revenue growth, 104% in 3Q18 YoY
• Trades below Thai Industrials at 19CE* 4.1x PB, offers much higher ROE, and a solid balance sheet
• Risks: Delay in construction, volatility in raw materials prices

* Consensus Estimates

2. Renesas: Visit Suggests Utilisation Rate Rebound Could Take Longer Than Sell-Side Expects

We visited Renesas Electronics (6723 JP) this week to discuss progress on inventory reduction and its likely ramp of utilisation rates/wafer throughput, as well as to gather further details on the IDT acquisition and its long -term strategy. On the whole, we continue to like the long-term picture, consider the stock to be undervalued and believe investors with long time horizons should be looking at the stock on the long side. However, our discussions suggested to us that while production cuts to reduce inventory should be completed this month or at worst in 1Q2019, a ramp in utilisation rates could take longer than is implied by consensus.

3. China Tower: Changing Our View to Positive. Low Cost Expansion Should Generate Better Returns

At the time of the IPO we were quite negative on China Tower (788 HK) prospects. However, in recent calls and meetings our view has changed and become more constructive. Chris Hoare now believes that China Tower is managing to generate co-location growth outside the Master Services Agreement (MSA) and at a much lower level of capital intensity (perhaps up to 50%) than indicated in the IPO. Management has also proven to be more open to shareholders than expected and with lower capex, higher FCF generation we upgrade to a BUY with a HK$1.60 target price.  The stock has started to move as the market has begun to understand the more positive outlook. It will be interesting to see if China Tower is allowed to retain these benefits long term.

Summary China Tower forecasts: 

4. TRADE IDEA – Toyota Industries (6201 JP) Stub: Riding the Automation Wave

If ever there was a stub business that is poised to capitalize on global trends of factory automation, automated logistics handling and electric vehicle prevalence, it is that of Toyota Industries (6201 JP). In August, I took an in-depth look at the major businesses of Toyota Industries and concluded that the market was not giving the company credit for the global leadership it has established in the forklifts and automobile A/C compressor businesses, nor for the progress it has made in the logistics equipment business. While the market’s oversight appeared to have corrected in September and October as the discount to NAV contracted from 34% to 25%, the trend has since reversed and the discount is back at trough levels of 35%. In August, I implied that this would be a good trading opportunity. Today, I explicitly recommend going long the stub.

In this insight I will cover:

• A market-neutral trade setup 
• A review of the core unlisted businesses
• Alternative data used to gauge performance in the core business
• Risks of the trade
• A recap of ALL my stub trade ideas on Smartkarma, including track record of performance

5. Doosan Bobcat – Negative on the North American Housing Market Turning Downwards

We believe that the consensus earnings estimates of Doosan Bobcat Inc (241560 KS) are likely to revised down by 10-15% in the next 6-12 months, negatively impacted by the faster than expected downturn in the North American housing construction market. Currently, Doosan Bobcat stock price is at 32,900 won. We expect 15% or more downside risk on this stock over the next 6-12 months. 

The US is the biggest market for the company. The US housing starts is an important indicator for the company since the US housing starts has a big impact on the demand for compact construction equipment. You could see from the charts below that US housing starts has been on a strong rebound since 2009. However, since early part of this year, there are signs that the US housing starts is beginning to soften and turn down.  

Home prices are starting to decline in the US – Most recently in 3Q18, the median sales price of houses sold in the US was $325,700, down 3.6% from the peak of $337,900 in 4Q17. The list of cities/regions with recent declining home prices in North America are as follows: Vancouver (Canada), Manhattan, NYC, Seattle, WA, San Francisco, CA, San Diego, CA, Toronto (Canada), and Los Angeles, CA.

In this briefing:

1. Weichai Power(2338.HK)： Fuel Cell Not the Answer (Yet), More Boldness Needed on All-Electric
2. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much
3. CKD (6407) Hit Buy China Slowdown. Now Excessively Cheap and Cutting Costs.
4. S&P 500 Revisiting 2,600 Support
5. Wonik Merger Swap: Div-Adjusted Yield Is Now at 4.17% – Cancellation Risk Is Slim

1. Weichai Power(2338.HK)： Fuel Cell Not the Answer (Yet), More Boldness Needed on All-Electric

Weichai Power, China’s largest independent Diesel engine producer, has been looking for a new core business to survive in long term downward trend of its current core business (Diesel engine for commercial vehicle and construction machines) since 2012 when it acquired 25% stake of KION Group AG (KGX GR). By now Weichai owns KION (materials handling equipment), Dematics (integrated automated supply chain technology, directly own ed by KION),  Power Solutions International (PSIX US) (cleantech engine). It also has stakes in Ballard Power Systems (BLDP CN) (PEM fuel cell products), Ceres Power Holdings (CWR LN) (fuel cell technology and engineering). Lately, Weichai entered into an agreement with Westport Fuel System (WPRT.US) to develop and commercialise HPDI 2.0.

It seems Weichai decides to put its chip on fuel cell and low-emission engines. However, our analysis shows all the above investment would not be enough to secure Weichai’s market outlook in the next 5-10 years. 

This note focus on an evaluation of Weichai’s technology choices on a 5-10 year time horizon. We will discuss the company’s 12-months view in another note.   

2. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

Bharat Heavy Electricals (BHEL IN) had announced a sizeable share buyback a couple of weeks ago. This buyback amounting to total Rs16.3 bn has opened yesterday, but we think that it is unlikely to help much. In the coming years, the Indian power distribution companies (DISCOMs) are likely to buy more power from renewable sources and the proposed changes in regulation will expedite the shift. In addition, resolution of power assets in distress continues to remain slow and new orders for Bharat Heavy Electricals (BHEL IN) which is already struggling with slow moving orders, remain sluggish. Another interesting development is shift in interest from company’s key customers. For example, NTPC Ltd (NTPC IN) is exploring acquisition opportunities much more than greenfield expansion. All of this is certainly bad news for the Bharat Heavy Electricals (BHEL IN) stock. While the PAT nos. are small in absolute terms and even a slight positive change will make valuations look attractive for the stock, this will not have a meaningful impact unless things improve structurally for the company.

3. CKD (6407) Hit Buy China Slowdown. Now Excessively Cheap and Cutting Costs.

To us the shares are have now fully discounted the current spate of bad news. The company has a very strong balance sheet and owns 10% in itself. The shares are on 0.9x book, they yield 3.7% and trade on a 3/20 EV/ebitda multiple of 3.8x, assuming ebitda next year of Y16.5bn. Unless one is exceedingly bearish on the outlook for the global economy, then these shares are starting to look attractive here. They have fallen 65% year to date, yet longer term management has a clear strategy with regards to improving profitability.

4. S&P 500 Revisiting 2,600 Support

The S&P 500 was not able to break through the 2,817 and 100-day moving average resistance levels last week, and has now fallen abruptly back to test 2,600 support. For now our outlook remains cautious and we continue to expect heightened volatility and horizontal consolidation between the aforementioned support and resistance levels. Absent any real clarity in regards to Fed policy or U.S.-China trade relations, the S&P 500 is vulnerable to a breakdown.  We highlight opportunities within Pharmaceuticals and Waste Services, two areas of the market with defensive characteristics that currently exhibit timely technicals.

5. Wonik Merger Swap: Div-Adjusted Yield Is Now at 4.17% – Cancellation Risk Is Slim

• Wonik IPS (240810 KS) / Wonik Tera Semicon (123100 KS) merger got shareholder approval yesterday. Spread now stands at 4.28%. Spread peaked at 5.12% on Dec 12. Dividend-adjusted spread is 4.17%.
• Tera Semicon is a bit of a concern. Its stock purchase price is 1.38% higher than current price. Worst case would be half of the minority shareholders claiming rights. Even if so, this would be less than ₩60bil. The company is liquid enough to absorb it.
• Local institutional arb traders have been seen doing this trade, at least partly. I’d make this trade when spread widens to 5~6%. I expect it to get to this level very soon. 

In this briefing:

1. HDC Holdings Holdco Trade: Status Update & Recommended Action
2. Revisiting the Renewable Energy Space

1. HDC Holdings Holdco Trade: Status Update & Recommended Action

• HDC Holdings (012630 KS) / HDC-OP (294870 KS) stub trade yield is now 0.38%. Price ratio is still below -1 σ. It is close to yearly low. Holdco discount now stands at 47.92% to NAV.
• The major shareholder Chung Mong-kyu bought an additional 0.63% stake for ₩16.1bil from Dec 6~10. I didn’t expect it. But it now seems that the owner buying factor is truly over.
• I’d wait a bit longer to capitalize on this newly developed situation. Price ratio is close to yearly low. Yearend dividend factor should be helping the situation.

2. Revisiting the Renewable Energy Space

We checked on two stocks today that are well-known in the renewable energy space, namely solar and wind power, to see how things were going. We may not be tree huggers ourselves, but it’s fair to say that sustainable investing is pretty big these days. Here’s some run-down.

• GUNKUL posting impressive earnings growth of 57% (normalized) on the back of a 30% revenue growth, and they’re still hoping to see another 25% revenue growth in 2019 as new projects in Japan and Thailand (floating panel) start operations soon.
• DEMCO also growing earnings 23% on the back of more modest revenue growth of just 6%, but management is far less confident on this front having faced issues with land reclamation rights and design changes.
• An interesting point in the visit was the fact that GUNKUL wants to establish a very large base of solar roofs by the time prices become competitive. Solar panel prices have fallen tenfold since they were first introduced in Thailand.