The Ministry of Industry Affairs and Communications (MIC, the regulator) will allocate 2.2 GHz of new spectrum bandwidth by the end of March equal to 2.8x the existing spectrum base. This is not unexpected but we think this is a good opportunity to re-iterate some of the positive points on 5G spectrum as operators make their final applications this month and we wait for a final decision in six weeks. Importantly, with ten spectrum channels, not everyone will be treated equally although all should benefit. We expect Rakuten Inc (4755 JP) to pick up one-two bands whilst KDDI Corp (9433 JP) , NTT Docomo Inc (9437 JP) and Softbank Corp (9434 JP) should all receive at least two.
We remain constructive overall and continue to believe that global equities (MSCI ACWI) are going through a bottoming process. Opportunities exist but Sector leadership is mixed. In our February International Strategy document, we explore various themes which lead to our overall constructive outlook, as well as a technical appraisal of each Sector and the investable opportunities therein.
Ryohin Keikaku (7453 JP) has downgraded full-year forecasts for its Muji retail chain but still expects record sales and solid profit growth in FY2018.
Overseas sales have been going from strength to strength, but previously stellar results at home have weakened, particularly in the home and accessories category which is under pressure from competitors, including even Nitori (9843 JP).
Muji is responding and also has big plans to grow food retailing, a big potential market.
The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.
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We remain constructive overall and continue to believe that global equities (MSCI ACWI) are going through a bottoming process. Opportunities exist but Sector leadership is mixed. In our February International Strategy document, we explore various themes which lead to our overall constructive outlook, as well as a technical appraisal of each Sector and the investable opportunities therein.
Ryohin Keikaku (7453 JP) has downgraded full-year forecasts for its Muji retail chain but still expects record sales and solid profit growth in FY2018.
Overseas sales have been going from strength to strength, but previously stellar results at home have weakened, particularly in the home and accessories category which is under pressure from competitors, including even Nitori (9843 JP).
Muji is responding and also has big plans to grow food retailing, a big potential market.
The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.
We have been struck by the degree of underperformance of the construction machinery names despite strong earnings performance. While the cyclical nature of the names makes judging performance purely on earnings results (or even the outlook) hazardous, in this case we believe the market has been premature and excessive in its derating of these stocks which have sold off to similar levels as the WFE names such as Tokyo Electron (8035 JP) and Robotics names such as Fanuc Corp (6954 JP).
While it is possible that Komatsu Ltd (6301 JP), Hitachi Construction Machinery (6305 JP) and Caterpillar Inc (CAT US) have sold off partly due to their China exposure, it needs to be emphasised that 1) these companies are no longer heavily dependent on China and revenue exposure is 12% for HCM, 10% for CAT and 7% for Komatsu, and 2) while the Chinese market at about 60k excavators is probably close to the top of its cycle, it is not a bubble like in 2010 when it 111k units and thus a collapse in demand is unlikely (though a decline is).
As the table below notes, earnings estimates for the construction machinery companies have only tapered marginally from their peaks, and while find the forecasts for continued growth into 2020 somewhat optimistic the resilience of mining demand means we are disinclined to dismiss them out of hand. On the other hand estimates for WFE and Robot names have dropped significantly, but despite this, share price performance is similar for all three categories of stocks. We discuss this stark discrepancy further below.
Change in 2019 OP Estimate Vs. Peak
Peak OP Estimate Date
Peak to Trough Share Price Change
Share Price Vs. Peak
Peak Share Price Date
Caterpillar
-6.4%
Aug 18
-35.2%
-21.4%
Jan 18
Komatsu
-2.1%
Dec 18
-49.7%
-38.8%
Jan 18
Hitachi Construction Machinery
-4.6%
Oct 18
-50.5%
-41.2%
Feb 18
Average
-4.4%
-45.1%
-33.8%
ASML
-10.1%
Jan 19
-31.2%
-14.4%
Jul 18
Applied Materials
-38.4%
Apr 18
-53.2%
-36.8%
Mar 18
LAM Research
-28.7%
Apr 18
-46.4%
-21.3%
Mar 18
Tokyo Electron
-36.6%
Jul 18
-49.9%
-32.4%
Nov 17
Average
-28.5%
-45.2%
-26.2%
Fanuc
-44.7%
Mar 18
-52.9%
-42.4%
Jan 18
Yaskawa
-34.7%
Mar 18
-58.5%
-47.0%
Jan 18
Harmonic Drive Systems
-43.2%
May 18
-65.9%
-49.3%
Jan 18
Average
-40.9%
-59.1%
-46.2%
Source: Bloomberg, LSR
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Ryohin Keikaku (7453 JP) has downgraded full-year forecasts for its Muji retail chain but still expects record sales and solid profit growth in FY2018.
Overseas sales have been going from strength to strength, but previously stellar results at home have weakened, particularly in the home and accessories category which is under pressure from competitors, including even Nitori (9843 JP).
Muji is responding and also has big plans to grow food retailing, a big potential market.
The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.
We have been struck by the degree of underperformance of the construction machinery names despite strong earnings performance. While the cyclical nature of the names makes judging performance purely on earnings results (or even the outlook) hazardous, in this case we believe the market has been premature and excessive in its derating of these stocks which have sold off to similar levels as the WFE names such as Tokyo Electron (8035 JP) and Robotics names such as Fanuc Corp (6954 JP).
While it is possible that Komatsu Ltd (6301 JP), Hitachi Construction Machinery (6305 JP) and Caterpillar Inc (CAT US) have sold off partly due to their China exposure, it needs to be emphasised that 1) these companies are no longer heavily dependent on China and revenue exposure is 12% for HCM, 10% for CAT and 7% for Komatsu, and 2) while the Chinese market at about 60k excavators is probably close to the top of its cycle, it is not a bubble like in 2010 when it 111k units and thus a collapse in demand is unlikely (though a decline is).
As the table below notes, earnings estimates for the construction machinery companies have only tapered marginally from their peaks, and while find the forecasts for continued growth into 2020 somewhat optimistic the resilience of mining demand means we are disinclined to dismiss them out of hand. On the other hand estimates for WFE and Robot names have dropped significantly, but despite this, share price performance is similar for all three categories of stocks. We discuss this stark discrepancy further below.
When the Tender Offer / MBO for Kosaido Co Ltd (7868 JP) was announced last month, my first reaction was that this was wrong. It was couched as being management-supportive, had one large independent shareholder agreeing to tender, and the it was touted as an effort to improve the printing and other “info” businesses such as staffing, and similar.
There was no mention of the fact that 94+% of the profits the last few years came from a majority stake in an external company which conducted funeral rites and services across a well-known chain of six large funeral parlours in Tokyo. Neither that company’s name nor the business segment it operates in were mentioned in the document (Japanese only) announcing the intention to conduct the MBO and if you look on the Kosaido website, you have to dig somewhat deeply to figure out that it is even a thing. In the company’s quarterly statements and semi-annual presentations of earnings, there is one line with revenues. One has to go into the fine print of the yukashoken hokokusho to discover more, and if one does, one sees that it is the profitable funeral parlour business which is effectively being purchased at 0.5x book and the rest of the company is being purchased at 1x book.
This is a virtual asset strip in progress. It is the kind of thing which gives activist hedge funds a bad name, but when cloaked in the finery of “Private Equity”, it looks like renewal of a business.
This company is an example of why investors should be spending more time on their stewardship and the governance of their portfolio companies.
It is also why investors should be taking a very close look at the METI request for public comment on what constitutes “Fair M&A.”
It is a decent premium but an underwhelming valuation. Because of the premium, and its smallcap nature, I expect this gets done.
If deals like this start to not get done, that would be a bullish sign. Investors will finally be taking the blinders off to unfair M&A practices.
Shortly afterwards, an activist did come forward. Long-time Japan activist Yoshiaki Murakami bought 5% through his entity Reno KK, and later lifted his stake (combined with affiliates) to 9.55%. I thought the stock had run too far at that point (¥775/share). While still cheap, I did not expect Bain to lift its price by 30+% and I did not expect a white knight to arrive quickly enough. This was discussed in Kosaido: Activism Drives Price 30+% Through Terms.
The New News
In the wee hours of Monday 18 February, with 11 days left to the Tender Offer, toyokeizai.net published an article (partially paywalled) suggesting that the longstanding external auditor Mr. Nakatsuji and lead shareholder Sakurai Mie (descendent of the founder of Kosaido, who originally founded a company called 桜井謄写堂 (Sakurai Transcription) in 1949, which later became Sakurai Kosaido, then just Kosaido) were against the takeover.
THAT is interesting. And the backstory here is even more interesting.
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Ryohin Keikaku (7453 JP) has downgraded full-year forecasts for its Muji retail chain but still expects record sales and solid profit growth in FY2018.
Overseas sales have been going from strength to strength, but previously stellar results at home have weakened, particularly in the home and accessories category which is under pressure from competitors, including even Nitori (9843 JP).
Muji is responding and also has big plans to grow food retailing, a big potential market.
The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.
We have been struck by the degree of underperformance of the construction machinery names despite strong earnings performance. While the cyclical nature of the names makes judging performance purely on earnings results (or even the outlook) hazardous, in this case we believe the market has been premature and excessive in its derating of these stocks which have sold off to similar levels as the WFE names such as Tokyo Electron (8035 JP) and Robotics names such as Fanuc Corp (6954 JP).
While it is possible that Komatsu Ltd (6301 JP), Hitachi Construction Machinery (6305 JP) and Caterpillar Inc (CAT US) have sold off partly due to their China exposure, it needs to be emphasised that 1) these companies are no longer heavily dependent on China and revenue exposure is 12% for HCM, 10% for CAT and 7% for Komatsu, and 2) while the Chinese market at about 60k excavators is probably close to the top of its cycle, it is not a bubble like in 2010 when it 111k units and thus a collapse in demand is unlikely (though a decline is).
As the table below notes, earnings estimates for the construction machinery companies have only tapered marginally from their peaks, and while find the forecasts for continued growth into 2020 somewhat optimistic the resilience of mining demand means we are disinclined to dismiss them out of hand. On the other hand estimates for WFE and Robot names have dropped significantly, but despite this, share price performance is similar for all three categories of stocks. We discuss this stark discrepancy further below.
When the Tender Offer / MBO for Kosaido Co Ltd (7868 JP) was announced last month, my first reaction was that this was wrong. It was couched as being management-supportive, had one large independent shareholder agreeing to tender, and the it was touted as an effort to improve the printing and other “info” businesses such as staffing, and similar.
There was no mention of the fact that 94+% of the profits the last few years came from a majority stake in an external company which conducted funeral rites and services across a well-known chain of six large funeral parlours in Tokyo. Neither that company’s name nor the business segment it operates in were mentioned in the document (Japanese only) announcing the intention to conduct the MBO and if you look on the Kosaido website, you have to dig somewhat deeply to figure out that it is even a thing. In the company’s quarterly statements and semi-annual presentations of earnings, there is one line with revenues. One has to go into the fine print of the yukashoken hokokusho to discover more, and if one does, one sees that it is the profitable funeral parlour business which is effectively being purchased at 0.5x book and the rest of the company is being purchased at 1x book.
This is a virtual asset strip in progress. It is the kind of thing which gives activist hedge funds a bad name, but when cloaked in the finery of “Private Equity”, it looks like renewal of a business.
This company is an example of why investors should be spending more time on their stewardship and the governance of their portfolio companies.
It is also why investors should be taking a very close look at the METI request for public comment on what constitutes “Fair M&A.”
It is a decent premium but an underwhelming valuation. Because of the premium, and its smallcap nature, I expect this gets done.
If deals like this start to not get done, that would be a bullish sign. Investors will finally be taking the blinders off to unfair M&A practices.
Shortly afterwards, an activist did come forward. Long-time Japan activist Yoshiaki Murakami bought 5% through his entity Reno KK, and later lifted his stake (combined with affiliates) to 9.55%. I thought the stock had run too far at that point (¥775/share). While still cheap, I did not expect Bain to lift its price by 30+% and I did not expect a white knight to arrive quickly enough. This was discussed in Kosaido: Activism Drives Price 30+% Through Terms.
The New News
In the wee hours of Monday 18 February, with 11 days left to the Tender Offer, toyokeizai.net published an article (partially paywalled) suggesting that the longstanding external auditor Mr. Nakatsuji and lead shareholder Sakurai Mie (descendent of the founder of Kosaido, who originally founded a company called 桜井謄写堂 (Sakurai Transcription) in 1949, which later became Sakurai Kosaido, then just Kosaido) were against the takeover.
THAT is interesting. And the backstory here is even more interesting.
Carlyle, along with SBI, plans to sell the rest of its stake in Aruhi Corp (7198 JP) for around US$280m.
Aruhi listed in Dec 2017, when Carlyle sold 18m shares. This is the second and final tranche of shares owned by Carlyle. The total sale accounts for 41% of the company’s outstanding shares making it a relatively large deal to digest.
However, the shares have done well since listing and the stock scores well on our framework. Valuations appear reasonable, if the company is able to achieve its mid-term targets.
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Softbank has announced a buyback of ¥600bn – its largest buyback ever. At ~¥10,500/share it is 57mm shares or 5.2% of shares out. At ¥12,000/share it is 50mm shares or 4.6%. The “official” float is about 68.7% or 750mm shares. However, by Travis’ estimate, only 44.5% of shares out or 488mm shares are Real World Float. 57mm shares out of 488mm shares is 11.7%. That is a non-negligible portion of float, and will mean significant reduction in foreign active management exposure to Softbank, or significant reduction in individual investor exposure to Softbank, or both.
Travis Lundy wrote the buyback will have further impact on the stock price simply because of flow dynamics. It isn’t easy to buy 10% of float. And we should remember that the BOJ is still buying ¥100bn+ of Softbank shares per year as it continues to buy ¥6trln of ETFs per year. And given the stock will be in the top momentum ranks of large cap Japan, Travis expects momentum flows will join the party adding more inflow.
For trading types, he thought Softbank was a buy, relatively and on an absolute basis. The Japan market is CHEAP on a current year and forecast year ahead, which suggests either the market is “wrong” or economic headwinds are picking up to a greater extent than pundits suggest.
The pre-conditons have been fulfilled and Delta Electronics (2308 TT)will now move to a tender offer. But there exist a number of unknowns for the transaction, which could delay the Offer timetable.
Although the initial wording in the August conditional voluntary tender offer announcement suggests the offer will be for ALL shares, there is talk there may be a maximum acceptance condition, therefore possible clawback for shareholders tendering. A rumoured 60% maximum translates to a minimum 50% pro-rata, potentially 67% if the family tenders 40% and the rest of holders tender half.
It is not clear whether the FY18 dividend will be netted. DELTA has announced two sets of quarterly results since the initial Offer announcement and it would be unjust for DEISG to net off any dividend. It would likely suit the family to receive the dividend. The Offer is pitched at a 1.79% premium to the then-current price. If the dividend is netted, then the Offer price will, in fact, be at a discount to last close as of announcement. DELTA will announce its full-year dividend tomorrow (18th February) and the terms of the deal may also be announced the same day. The AGM to ratify the dividend will take place around the 2 April.
Currently trading at terms or a gross/annualised spread of 4.6/21%, if including a Bt3.30 FY18 dividend and mid-May payment. That looks overly tight in the face of timing delays and actual consideration to be paid if indeed it comes out to be a partial offer.
Three months ago, Minebea Mitsumi (6479 JP) announced it would launch a Tender Offer for U Shin and it would take just under three months until the approvals were received and it could officially start the Tender Offer process. The background to the Tender Offer was discussed in Minebea Mitsumi Launches Offer for U-SHIN in early November. Travis first conclusion in November was that this was the “riskiest” straight-out non-hostile TOB he had seen in a while. Minebea Mitsumi has now announced the launch of its Tender Offer, at the same price as originally planned (¥985/share).
This deal is still perplexing to Travis. It’s easy enough from an industrial standpoint. Why not buy relatively cheap assets then see if you can cross-sell or assume some attrition? But for investors, he wonders why they put up with this. The process of reaching a “fair” valuation is, by definition, conflicted. It cannot NOT be conflicted. And just because some independent directors who don’t have skin in the game, and may have no clue about corporate valuation methodology, or fair market price, agree to a price that the acquiree’s managers, not wanting to lose their jobs, agree to doesn’t make this “fair.”
The tender offer period is QUITE long. Most tender offers are 30 days in order to give time for people to tender or “offer sufficient time for a rival bidder.” This time Travis thinks it is longer so people can take their time and get bored and tender.
Travis would sell shares now and use the balance sheet elsewhere until an activist shows his hand. If no activist, this deal is not an interesting one.
After multiple news outlets reported that LG Uplus Corp (032640 KS) will finalise a transaction with the CJ Hello, a deal was done at ₩800bn (instead of ₩1tn speculated), and only 50%+1 share instead of the full 53.92% stake held by CJ ENM (035760 KS). The acquisition price of ₩20,659 is a 107% premium to last price and translates to a EV/EBITDA multiple of 6.6x.
This is a straight stock acquisition deal. CJ Hello will be a subsidiary of LG Uplus and will continue to exist as a separate listed company. CJ ENM still owns nearly 4% CJH stake. SKT owns 8.61%.
LG Group is publicly saying that they have no plan of an immediate merger, which means neither party requires shareholder approval. But the transaction is subject to local regulator approval – MSIT and Korea FTC. MSIT approval is not an issue. FTC rejected the SKT-CJH deal last time. This time, the FTC’s head Kim Sang-jo is hinting that this deal will go through.
LG Uplus’ acquisition of CJ Hellovision is likely to further accelerate the consolidation of the Korean cable TV/media sector. KT Corp (030200 KS)is now likely to aggressively try to acquire cable-operator D’Live. SK Telecom (017670 KS) has shown some interests in acquiring Tbroad cable company.
Glow announced that the Energy Regulatory Commission (“ERC”) has resolved to approve the merger with GPSC, provided Glow sells its Glow SPP1 plant before or at the same time as the merger. A number of conditions were also attached to some of the remaining power plants. No price has been disclosed for the 69.11% stake in Glow, ex the SPP1 plant, but it will be in reference to the Bt94.892 Offer price previously announced, net of expenses with selling SPP1 and the reduced synergy thereon.
Given SPP1 is an immaterial contributor (~5%) to Glow, in terms of revenue, it can be argued that GPSC may make only a minimal change to the Offer price. Still, even a 5% downward adjustment would equate to a price below where Glow is trading.
The downside is ~8%, if using the closing price on the 11 October. Glow/GPSC/Engie want this deal to complete. I think the final Offer price will come in very close to that initially proposed. But I would not buy through Bt90, preferring to pick up shares at Bt89 or below. The merger is expected to be completed by next month, triggering a mandatory tender offer, which may take an additional 2 months or so to complete.
Sigma Healthcare released a 2-page Market Update saying the four month Business Review had identified A$100mm of annual cost savings, confirmed the FY19 EBIT guidance of A$75mn, and confirmed the FY20 EBITDA guidance of $55-60mm. The business review sees 10% underlying EBITDA growth from FY20 to FY23 so that after cost savings are included, FY23 sees the same EBITDA as FY19 [i.e. almost A$90mm].
On a standalone basis, at the end of FY22 looking towards FY23, at 8x EV/EBITDA, it looks like there is something like 60-80% upside. EBITDA might be worth even more than A$90mm in FY23 as long as the DCs can run at high capacity. And at mid-high teens PER that would be a pretty great result. They won’t get that 60-80% upside from now doing a deal with API, but they won’t have to wait for 4 years to get it either.
Travis expects another A$0.15 of value would do it. He doesn’t think they need A$0.20. The shares bounced and traded around A$0.80-1.00 from mid summer 2017 to mid-summer 2018. But that is when EBIT was supposed to fall to A$90mm. And that was nearer-term. Now we have a forecast of EBITDA of A$90mm and that is 3+ years out.
Travis thinks this could get done at 0.42-0.45 shares of API and A$0.23 of cash, given that would probably impact API shares a little bit, that would end up being a 10-15% bump vs original terms, but all told that would be pretty good – and almost a double from undisturbed.
KDDI Corp (9433 JP) announced its intention to conduct a Tender Offer for Kabu.com through a made-for-purpose SPC. The deal is not terribly different in scope than the one discussed in KDDI Deal for Kabu.com (8703 JP) Coming? about two weeks ago.
The Tender Offer is to purchase a minimum of 45,758,400 shares at ¥559/share, which is a 5.67% premium to last close and a 46.3% premium to the undisturbed price of 23 January 2019. Obtaining the minimum would get the combination of KDDI and MUFJ Securities (which currently holds 52.96% of the shares outstanding, and will not tender) to 66.67% which would allow the combination to do a Two Step Squeezeout, which KDDI states in the document that it intends to do.
Anti-trust and regulatory approvals are required (Travis can’t imagine any issues), and KDDI expects that the Tender Offer will commence in late April. This looks pretty easy as a deal, with few impediments. A rival bid is unlikely – KDDI has a headstart with the shares of MUFG Bank which have committed to the deal.
This is going to be boring. One can make markets, carry it, or allocate capital to something more interesting. However Kabu.com’s ¥6/share dividend for end March 2019 WILL BE PAID according to a press release by Kabu.com today after the close. That means there will be a down-shift in price on the ex-date of the dividend at end-March.
Via subsidiary NSITEXE, Inc, Denso has acquired a stake in Californian start-up quadric.io. NSITEXE was established to develop high performance, next generation semiconductor devices for automated driving solutions. quadric’s edge processing units compliment this technology push.
Xingfa announced its major shareholder, Guangxin Aluminium (a wholly-owned Guangdong SASAC vehicle), has acquired 5,000 shares, lifting its stake to 30.001%, triggering a mandatory general offer. The offer price is $5.60, a premium of just 2.94% to last close.
Guangxin, together with certain management of Xingfa, attempted to take Xingfa private at $3.70/share back in 1H17. That scheme failed comprehensively, which was a good outcome for minorities as FY17 net income increased 28%. 1H18 profit was also a 25% improvement over the corresponding period.
The offer price is in line with where Xingfa traded last October and is 23% below the recent peak back in mid-June 2018. It is also 37% below where China Lesso Group Holdings (2128 HK) acquired its 26.3% stake in April last year.
There has to be some behind the scenes play for Xingfa’s shares, and this potentially centres on China Lesso. While a look at CCASS shows Liao Yuqing (an ED in Xingfa) intriguingly moving his entire 48.2mn (11.5% of shares out) outside of CCASS in early December 2018.
OSLO NS is the target of competing tender offers from Euronext NV (ENX FP)andNasdaq Inc (NDAQ US). Euronext owns 5.3% and has irrevocables for 45.2% of OSLO NS shares, for 50.5% total. It launched an Offer to acquire all shares at NOK 145, and just raised that to NOK 158 on February 11, 2019. Nasdaq has irrevocables for 35.2% of OSLO NS shares and has launched an Offer to acquire all OSLO NS shares at NOK 152 per share. Nasdaq’s Offer received the unanimous recommendation of Oslo Børs VPS’s Board when it was announced. The IFA opined that NOK 152 per share is above the top end of what shareholders could expect.
Nasdaq’s undertakings are irrevocable and binding, including in the event of a higher offer. The pre-acceptances further include an obligation on the part of the pre-accepting shareholders not to accept the Euronext Offer. Irrevocables for both bidders have an end date of 31 December 2019, after which they are no longer binding.
Nasdaq, which is conditional on a 90% acceptance level, seems to have the weaker hand since its acceptance threshold condition won’t be met unless Euronext folds its cards and walks away; while Euronext (with a 50.01% acceptance condition) can keep its 50.5% “stake” as long as it gets regulatory approval. Therefore, Nasdaq would need to waive its 90% acceptance condition in order to stay in the game.
The Norwegian Ministry of Finance MoF may resolve this by approving both bidders, provided they reach a super majority acceptance threshold of two-thirds or 90% of shares outstanding (but not less). In this scenario, either party will have enough to block the other from reaching the threshold while the irrevocables are binding.
If the MoF says both parties have approval if they get to whatever super majority the MoF decides or is statutorily permitted to impose, and puts a deadline on getting there of some date after the irrevocable lock-up expiration (say, January 31, 2020), then the formerly locked-up shares are free to go to whichever bidder they chose.
I estimate HLG’s discount to NAV at 41% compared to its one-year average of 38%. The implied stub is right at the 2STD extreme and excluding a brief dip in late April 2018, is at the lowest level since June 2013.
What assets HLG does directly own at the stub level are intertwined with HLP’s own investments. There is therefore, very little to distinguish between the two companies. In addition, HLG has gradually offloaded its HK properties – to HLP no less – further increasing its exposure to China and blurring the lines between HLP and HLG’s business exposure.
HLG has also been increasing its stake in HLP since June 2011, from 48.96% to 57.62% as at 31 Dec 2018. It’s a pretty astute trade to sell a property at book to HLP, then “buy” it back indirectly via increasing its stake in HLP, which trades at 0.6x P/B.
There is no significant catalyst for the NAV discount to narrow. And liquidity does play a role, although HLG’s volume has narrowed the gap to HLP’s in recent years. Nevertheless, a ~40% discount to NAV is extreme for a straightforward, passive, single stock holdco structure.
Athaporn Arayasantiparb, CFA discussed his one-on-one with Intouch. Of interest is his discussions on the stub assets specifically InVent, a venture capital arm and considered the market leader in growth stage funding. In 2018, InVent invested Bt30m into ytm thailand, an end-to-end digital marketing and feedback platform, which used the proceeds to buy offline digital access; Bt40m into Choco CRM, a CRM and POS (point of sales) platform for SME; and Bt40m into E Studio, a B2C lifestyle portal.
Other investments discussed by Athaporn, at the stub level, include Wongnai and HSN. Wongnai is an online foodie guide and one of their largest investments to date, boasted 8m active users, 120m page views, 200,000 patron restaurants, and 10m pictures posted so far. Revenue grew 60% in 2018 to Bt250mn, and is expected to grow at 50%. HSN is an online shopping venture between Intuch and Hyundai, which managed to breakeven on a net basis.
The overall value of these investments, and the estimated 11 other start-up companies under InVent, is very much a “finger in the air” calculation. They may exceed the value of Intouch’s 41.1% stake in Thaicom Pcl (THCOM TB), but that still would be just 1% of NAV.
I estimate Intouch’s discount to NAV at ~21% (vs. the one-year average of 27%), having significantly narrowed in response to rumours of a purported sale of Thaicom (discussed in StubWorld: Intouch Gains On Possible Sale of Thaicom). At the time, I thought Intouch had run its course, noting Intouch had denied any definitive approach/agreement.
New Street Research also met with AIS and remains cautious on this telco in the current slowing environment ahead of delayed elections.
My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions. These may be indicative of share pledges. Or potential takeovers. Or simply help understand volume swings.
Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.
Horiba’s share price has rebounded on FY Dec-18 results that were above management’s most recent guidance and better than we had expected. Consolidated operating profit was up 7.5% on a 7.8% increase in sales, and net profit up 37.0% following extraordinary gains (vs. losses the previous year) and a lower effective tax rate.
4Q results were weak, primarily due to the downturn in semiconductor capital spending, but this was no surprise. Total consolidated operating profit was down 10.3% year-on-year on a 2.3% increase in sales in the three months to December, while operating profit on Semiconductor Instruments & Systems (primarily mass flow controllers) was down 32.8% on a 15.8% decrease in sales.
Looking ahead, management is guiding for year-on-year declines in both sales and profits in the six months to June, again due to weak demand for semiconductor equipment, followed by a sharp rebound in 2H and low single-digit growth FY Dec-19 as a whole. Judging from the semiconductor equipment order flow, it appears that a weak 1H will be hard to avoid, while there is as yet no sign pointing to recovery. Nevertheless, we have raised our own sales and profit estimates for this fiscal year and next based on the absolute levels of orders and sales.
Automotive Test Systems and the company’s other businesses should continue to grow, supported by the acquisition of FuelCon AG of Germany (an industry leader in battery and fuel cell validation) and Manta Instruments of the U.S. (which makes nanoparticle tracking analysis systems). The issue, then, is how soon and how rapidly semiconductor related investments will recover. We suspect later and more slowly than management hopes, but in any case the downturn appears to have been discounted.
At ¥5,980 (Friday, February 15, closing price), Horiba has rebounded by 44% from its January 4 low of ¥4,155, but is still 38% below its ¥9,590 all-time high reached last May. It is now selling at 13.6x our EPS estimate for this fiscal year and 12.3x our estimate for FY Dec-20. These and other projected valuations are on the low side of their 5-year historical ranges. Once the recent bounce has been consolidated, there should be another buying opportunity for longer term investors.
WORST Q SINCE AUTUMN 2016 – Since our last Results Flash in November –Japan: Autumn Results & Revisions Flash – Flatlining + Weakest Quarter in Two Years– the operating and net profits of Japanese listed companies have peaked and declined by 2.0% and 7.5%, respectively while forecasts for the same have fallen by 1.7% and 4.1%. The stock market’s initial reaction to the peaking of earnings for this cycle was a sharp 15.5% decline which climaxed on Christmas Day. A softer tone from the US Federal Reserve and a weaker Yen have helped restore a degree of confidence and the recent 12.1% rally has taken aggregate market capitalisation back to early-December. As a result of the downturn in profits, trailing and forecast earnings multiples have reverted to August 2018 levels and can no longer be considered a bargain. For the restoration of a ‘normal’ market multiple (16.7x), either share prices have to rise by 18% (all else equal) or net income has to decline by a further 16%. Our money is on the latter being the more likely outcome.
Source: Japan Analytics
ROLLING TTMs – Our series of rolling trailing-twelve-month (TTM) quarterly aggregates of all listed companies confirm the profit peak. Revenues are still increasing by 5-6% a year, and by 1-2% a quarter, however, the rate of increase is slowing and the implied growth rate for the current quarter is just 0.5%. Operating Income declined by 1.9% qoq in the quarter just declared and will be flat this quarter, although, as few companies revise full-year forecasts with Q3 earnings results, this forecast should be considered optimistic. Operating margins are forecast to be 33bps lower than in TTM-3. TTM Net Income fell by 8% qoq, although yoy growth is still a positive 3%. The 1.6% forecast growth for this quarter implies that the most recent quarter had an excessive level of write-offs. We are not so sanguine.
SECTOR BREAKDOWNS – In the DETAIL section below we shall examine the trends in earnings results and forecasts for the 30 sectors that make up our Market Composite.
TW3 NORTH ASIA – This was a busy week for the North Asian team on Smartkarma. with 967 results announcements and 577 forecasts revisions in Japan and plenty of corporate activity in Korea including LG Uplus/CJ Hello. As is our wont here, we also had a number of providers take opposite sides on a number of issues (e.g. GMO Internet (9449 JP)).
The format is a little different this week with Insights grouped by vertical and split between Bullish and Bearish with no country separation. Any feedback for further improvements is always welcome!
NB: For chart and table sources other than those mentioned below, please refer to the original Insights.
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The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.
We have been struck by the degree of underperformance of the construction machinery names despite strong earnings performance. While the cyclical nature of the names makes judging performance purely on earnings results (or even the outlook) hazardous, in this case we believe the market has been premature and excessive in its derating of these stocks which have sold off to similar levels as the WFE names such as Tokyo Electron (8035 JP) and Robotics names such as Fanuc Corp (6954 JP).
While it is possible that Komatsu Ltd (6301 JP), Hitachi Construction Machinery (6305 JP) and Caterpillar Inc (CAT US) have sold off partly due to their China exposure, it needs to be emphasised that 1) these companies are no longer heavily dependent on China and revenue exposure is 12% for HCM, 10% for CAT and 7% for Komatsu, and 2) while the Chinese market at about 60k excavators is probably close to the top of its cycle, it is not a bubble like in 2010 when it 111k units and thus a collapse in demand is unlikely (though a decline is).
As the table below notes, earnings estimates for the construction machinery companies have only tapered marginally from their peaks, and while find the forecasts for continued growth into 2020 somewhat optimistic the resilience of mining demand means we are disinclined to dismiss them out of hand. On the other hand estimates for WFE and Robot names have dropped significantly, but despite this, share price performance is similar for all three categories of stocks. We discuss this stark discrepancy further below.
When the Tender Offer / MBO for Kosaido Co Ltd (7868 JP) was announced last month, my first reaction was that this was wrong. It was couched as being management-supportive, had one large independent shareholder agreeing to tender, and the it was touted as an effort to improve the printing and other “info” businesses such as staffing, and similar.
There was no mention of the fact that 94+% of the profits the last few years came from a majority stake in an external company which conducted funeral rites and services across a well-known chain of six large funeral parlours in Tokyo. Neither that company’s name nor the business segment it operates in were mentioned in the document (Japanese only) announcing the intention to conduct the MBO and if you look on the Kosaido website, you have to dig somewhat deeply to figure out that it is even a thing. In the company’s quarterly statements and semi-annual presentations of earnings, there is one line with revenues. One has to go into the fine print of the yukashoken hokokusho to discover more, and if one does, one sees that it is the profitable funeral parlour business which is effectively being purchased at 0.5x book and the rest of the company is being purchased at 1x book.
This is a virtual asset strip in progress. It is the kind of thing which gives activist hedge funds a bad name, but when cloaked in the finery of “Private Equity”, it looks like renewal of a business.
This company is an example of why investors should be spending more time on their stewardship and the governance of their portfolio companies.
It is also why investors should be taking a very close look at the METI request for public comment on what constitutes “Fair M&A.”
It is a decent premium but an underwhelming valuation. Because of the premium, and its smallcap nature, I expect this gets done.
If deals like this start to not get done, that would be a bullish sign. Investors will finally be taking the blinders off to unfair M&A practices.
Shortly afterwards, an activist did come forward. Long-time Japan activist Yoshiaki Murakami bought 5% through his entity Reno KK, and later lifted his stake (combined with affiliates) to 9.55%. I thought the stock had run too far at that point (¥775/share). While still cheap, I did not expect Bain to lift its price by 30+% and I did not expect a white knight to arrive quickly enough. This was discussed in Kosaido: Activism Drives Price 30+% Through Terms.
The New News
In the wee hours of Monday 18 February, with 11 days left to the Tender Offer, toyokeizai.net published an article (partially paywalled) suggesting that the longstanding external auditor Mr. Nakatsuji and lead shareholder Sakurai Mie (descendent of the founder of Kosaido, who originally founded a company called 桜井謄写堂 (Sakurai Transcription) in 1949, which later became Sakurai Kosaido, then just Kosaido) were against the takeover.
THAT is interesting. And the backstory here is even more interesting.
Carlyle, along with SBI, plans to sell the rest of its stake in Aruhi Corp (7198 JP) for around US$280m.
Aruhi listed in Dec 2017, when Carlyle sold 18m shares. This is the second and final tranche of shares owned by Carlyle. The total sale accounts for 41% of the company’s outstanding shares making it a relatively large deal to digest.
However, the shares have done well since listing and the stock scores well on our framework. Valuations appear reasonable, if the company is able to achieve its mid-term targets.
The declining and ageing population in Japan has been a major cause for concern to many Japanese companies.
Fancl Corp (4921 JP), is a relatively small player in the Japanese cosmetics and nutritional supplements space who is expected to benefit from the declining and ageing population.
Compared to the peer average, EV/Sales discount narrowed down significantly over the course of the last year. But we believe the discount remains the same on a growth adjusted basis.
Still too small for institutional investors to notice. But we expect them to start noticing the company over the coming years.
One of the cheapest stocks on a long term forward multiple, as we expect FANCL to sustain its high growth over a long period of time.
We are not sure if Fancl Corp (4921 JP) can ever be in the same league as Shiseido or Kao, but we certainly believe the company doesn’t deserve to be about 10% of the size of Shiseido. Thus, we have a very long-term bullish view on FANCL and expect to see the company’s market cap to double over the next 5-7 years
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Horiba’s share price has rebounded on FY Dec-18 results that were above management’s most recent guidance and better than we had expected. Consolidated operating profit was up 7.5% on a 7.8% increase in sales, and net profit up 37.0% following extraordinary gains (vs. losses the previous year) and a lower effective tax rate.
4Q results were weak, primarily due to the downturn in semiconductor capital spending, but this was no surprise. Total consolidated operating profit was down 10.3% year-on-year on a 2.3% increase in sales in the three months to December, while operating profit on Semiconductor Instruments & Systems (primarily mass flow controllers) was down 32.8% on a 15.8% decrease in sales.
Looking ahead, management is guiding for year-on-year declines in both sales and profits in the six months to June, again due to weak demand for semiconductor equipment, followed by a sharp rebound in 2H and low single-digit growth FY Dec-19 as a whole. Judging from the semiconductor equipment order flow, it appears that a weak 1H will be hard to avoid, while there is as yet no sign pointing to recovery. Nevertheless, we have raised our own sales and profit estimates for this fiscal year and next based on the absolute levels of orders and sales.
Automotive Test Systems and the company’s other businesses should continue to grow, supported by the acquisition of FuelCon AG of Germany (an industry leader in battery and fuel cell validation) and Manta Instruments of the U.S. (which makes nanoparticle tracking analysis systems). The issue, then, is how soon and how rapidly semiconductor related investments will recover. We suspect later and more slowly than management hopes, but in any case the downturn appears to have been discounted.
At ¥5,980 (Friday, February 15, closing price), Horiba has rebounded by 44% from its January 4 low of ¥4,155, but is still 38% below its ¥9,590 all-time high reached last May. It is now selling at 13.6x our EPS estimate for this fiscal year and 12.3x our estimate for FY Dec-20. These and other projected valuations are on the low side of their 5-year historical ranges. Once the recent bounce has been consolidated, there should be another buying opportunity for longer term investors.
WORST Q SINCE AUTUMN 2016 – Since our last Results Flash in November –Japan: Autumn Results & Revisions Flash – Flatlining + Weakest Quarter in Two Years– the operating and net profits of Japanese listed companies have peaked and declined by 2.0% and 7.5%, respectively while forecasts for the same have fallen by 1.7% and 4.1%. The stock market’s initial reaction to the peaking of earnings for this cycle was a sharp 15.5% decline which climaxed on Christmas Day. A softer tone from the US Federal Reserve and a weaker Yen have helped restore a degree of confidence and the recent 12.1% rally has taken aggregate market capitalisation back to early-December. As a result of the downturn in profits, trailing and forecast earnings multiples have reverted to August 2018 levels and can no longer be considered a bargain. For the restoration of a ‘normal’ market multiple (16.7x), either share prices have to rise by 18% (all else equal) or net income has to decline by a further 16%. Our money is on the latter being the more likely outcome.
Source: Japan Analytics
ROLLING TTMs – Our series of rolling trailing-twelve-month (TTM) quarterly aggregates of all listed companies confirm the profit peak. Revenues are still increasing by 5-6% a year, and by 1-2% a quarter, however, the rate of increase is slowing and the implied growth rate for the current quarter is just 0.5%. Operating Income declined by 1.9% qoq in the quarter just declared and will be flat this quarter, although, as few companies revise full-year forecasts with Q3 earnings results, this forecast should be considered optimistic. Operating margins are forecast to be 33bps lower than in TTM-3. TTM Net Income fell by 8% qoq, although yoy growth is still a positive 3%. The 1.6% forecast growth for this quarter implies that the most recent quarter had an excessive level of write-offs. We are not so sanguine.
SECTOR BREAKDOWNS – In the DETAIL section below we shall examine the trends in earnings results and forecasts for the 30 sectors that make up our Market Composite.
TW3 NORTH ASIA – This was a busy week for the North Asian team on Smartkarma. with 967 results announcements and 577 forecasts revisions in Japan and plenty of corporate activity in Korea including LG Uplus/CJ Hello. As is our wont here, we also had a number of providers take opposite sides on a number of issues (e.g. GMO Internet (9449 JP)).
The format is a little different this week with Insights grouped by vertical and split between Bullish and Bearish with no country separation. Any feedback for further improvements is always welcome!
NB: For chart and table sources other than those mentioned below, please refer to the original Insights.
Get Straight to the Source on Smartkarma
Smartkarma supports the world’s leading investors with high-quality, timely, and actionable Insights. Subscribe now for unlimited access, or request a demo below.
We have been struck by the degree of underperformance of the construction machinery names despite strong earnings performance. While the cyclical nature of the names makes judging performance purely on earnings results (or even the outlook) hazardous, in this case we believe the market has been premature and excessive in its derating of these stocks which have sold off to similar levels as the WFE names such as Tokyo Electron (8035 JP) and Robotics names such as Fanuc Corp (6954 JP).
While it is possible that Komatsu Ltd (6301 JP), Hitachi Construction Machinery (6305 JP) and Caterpillar Inc (CAT US) have sold off partly due to their China exposure, it needs to be emphasised that 1) these companies are no longer heavily dependent on China and revenue exposure is 12% for HCM, 10% for CAT and 7% for Komatsu, and 2) while the Chinese market at about 60k excavators is probably close to the top of its cycle, it is not a bubble like in 2010 when it 111k units and thus a collapse in demand is unlikely (though a decline is).
As the table below notes, earnings estimates for the construction machinery companies have only tapered marginally from their peaks, and while find the forecasts for continued growth into 2020 somewhat optimistic the resilience of mining demand means we are disinclined to dismiss them out of hand. On the other hand estimates for WFE and Robot names have dropped significantly, but despite this, share price performance is similar for all three categories of stocks. We discuss this stark discrepancy further below.
When the Tender Offer / MBO for Kosaido Co Ltd (7868 JP) was announced last month, my first reaction was that this was wrong. It was couched as being management-supportive, had one large independent shareholder agreeing to tender, and the it was touted as an effort to improve the printing and other “info” businesses such as staffing, and similar.
There was no mention of the fact that 94+% of the profits the last few years came from a majority stake in an external company which conducted funeral rites and services across a well-known chain of six large funeral parlours in Tokyo. Neither that company’s name nor the business segment it operates in were mentioned in the document (Japanese only) announcing the intention to conduct the MBO and if you look on the Kosaido website, you have to dig somewhat deeply to figure out that it is even a thing. In the company’s quarterly statements and semi-annual presentations of earnings, there is one line with revenues. One has to go into the fine print of the yukashoken hokokusho to discover more, and if one does, one sees that it is the profitable funeral parlour business which is effectively being purchased at 0.5x book and the rest of the company is being purchased at 1x book.
This is a virtual asset strip in progress. It is the kind of thing which gives activist hedge funds a bad name, but when cloaked in the finery of “Private Equity”, it looks like renewal of a business.
This company is an example of why investors should be spending more time on their stewardship and the governance of their portfolio companies.
It is also why investors should be taking a very close look at the METI request for public comment on what constitutes “Fair M&A.”
It is a decent premium but an underwhelming valuation. Because of the premium, and its smallcap nature, I expect this gets done.
If deals like this start to not get done, that would be a bullish sign. Investors will finally be taking the blinders off to unfair M&A practices.
Shortly afterwards, an activist did come forward. Long-time Japan activist Yoshiaki Murakami bought 5% through his entity Reno KK, and later lifted his stake (combined with affiliates) to 9.55%. I thought the stock had run too far at that point (¥775/share). While still cheap, I did not expect Bain to lift its price by 30+% and I did not expect a white knight to arrive quickly enough. This was discussed in Kosaido: Activism Drives Price 30+% Through Terms.
The New News
In the wee hours of Monday 18 February, with 11 days left to the Tender Offer, toyokeizai.net published an article (partially paywalled) suggesting that the longstanding external auditor Mr. Nakatsuji and lead shareholder Sakurai Mie (descendent of the founder of Kosaido, who originally founded a company called 桜井謄写堂 (Sakurai Transcription) in 1949, which later became Sakurai Kosaido, then just Kosaido) were against the takeover.
THAT is interesting. And the backstory here is even more interesting.
Carlyle, along with SBI, plans to sell the rest of its stake in Aruhi Corp (7198 JP) for around US$280m.
Aruhi listed in Dec 2017, when Carlyle sold 18m shares. This is the second and final tranche of shares owned by Carlyle. The total sale accounts for 41% of the company’s outstanding shares making it a relatively large deal to digest.
However, the shares have done well since listing and the stock scores well on our framework. Valuations appear reasonable, if the company is able to achieve its mid-term targets.
The declining and ageing population in Japan has been a major cause for concern to many Japanese companies.
Fancl Corp (4921 JP), is a relatively small player in the Japanese cosmetics and nutritional supplements space who is expected to benefit from the declining and ageing population.
Compared to the peer average, EV/Sales discount narrowed down significantly over the course of the last year. But we believe the discount remains the same on a growth adjusted basis.
Still too small for institutional investors to notice. But we expect them to start noticing the company over the coming years.
One of the cheapest stocks on a long term forward multiple, as we expect FANCL to sustain its high growth over a long period of time.
We are not sure if Fancl Corp (4921 JP) can ever be in the same league as Shiseido or Kao, but we certainly believe the company doesn’t deserve to be about 10% of the size of Shiseido. Thus, we have a very long-term bullish view on FANCL and expect to see the company’s market cap to double over the next 5-7 years
On Thursday the 14th Feb 2019, Pepper Food Service (3053 JP) announced its results for FY2018 and the guidance for both 1HFY2019 and FY2019. The company managed to grow its revenue by an impressive 75.3% YoY outperforming its own estimate by 6.4%.
However, the gross profit only grew by 69.9% during the year as the gross margin slipped 137bps in FY2018 driven by higher energy prices and wages. Higher wages were due to active recruitment of foreign workers within the food service industry which created a supply shortage. To tackle increasing costs, towards the end of the year, Ikinari Steak restaurants increased the prices of its steak. We believe the margin recovery witnessed in 4Q2018 was a direct result of this price increase.
Gross Margin Showing Signs of Recovery
Source: Company Disclosures
Pepper Food Services saw its EBIT margin decline by 20bps to 6.1% in FY2018, as revenue growth offset most of the gross margin drop through gains from operating leverage. However, its restaurants in New York City continued to underperform. The company expected those restaurants to turn a corner and start contributing to the overall EBIT from FY2018, however, those restaurants failed miserably and continued to drag the overall EBIT margin down. Hence, the company failed to meet its EBIT margin forecast with EBIT falling 4.6% short of company guidance.
Get Straight to the Source on Smartkarma
Smartkarma supports the world’s leading investors with high-quality, timely, and actionable Insights. Subscribe now for unlimited access, or request a demo below.
WORST Q SINCE AUTUMN 2016 – Since our last Results Flash in November –Japan: Autumn Results & Revisions Flash – Flatlining + Weakest Quarter in Two Years– the operating and net profits of Japanese listed companies have peaked and declined by 2.0% and 7.5%, respectively while forecasts for the same have fallen by 1.7% and 4.1%. The stock market’s initial reaction to the peaking of earnings for this cycle was a sharp 15.5% decline which climaxed on Christmas Day. A softer tone from the US Federal Reserve and a weaker Yen have helped restore a degree of confidence and the recent 12.1% rally has taken aggregate market capitalisation back to early-December. As a result of the downturn in profits, trailing and forecast earnings multiples have reverted to August 2018 levels and can no longer be considered a bargain. For the restoration of a ‘normal’ market multiple (16.7x), either share prices have to rise by 18% (all else equal) or net income has to decline by a further 16%. Our money is on the latter being the more likely outcome.
Source: Japan Analytics
ROLLING TTMs – Our series of rolling trailing-twelve-month (TTM) quarterly aggregates of all listed companies confirm the profit peak. Revenues are still increasing by 5-6% a year, and by 1-2% a quarter, however, the rate of increase is slowing and the implied growth rate for the current quarter is just 0.5%. Operating Income declined by 1.9% qoq in the quarter just declared and will be flat this quarter, although, as few companies revise full-year forecasts with Q3 earnings results, this forecast should be considered optimistic. Operating margins are forecast to be 33bps lower than in TTM-3. TTM Net Income fell by 8% qoq, although yoy growth is still a positive 3%. The 1.6% forecast growth for this quarter implies that the most recent quarter had an excessive level of write-offs. We are not so sanguine.
SECTOR BREAKDOWNS – In the DETAIL section below we shall examine the trends in earnings results and forecasts for the 30 sectors that make up our Market Composite.
TW3 NORTH ASIA – This was a busy week for the North Asian team on Smartkarma. with 967 results announcements and 577 forecasts revisions in Japan and plenty of corporate activity in Korea including LG Uplus/CJ Hello. As is our wont here, we also had a number of providers take opposite sides on a number of issues (e.g. GMO Internet (9449 JP)).
The format is a little different this week with Insights grouped by vertical and split between Bullish and Bearish with no country separation. Any feedback for further improvements is always welcome!
NB: For chart and table sources other than those mentioned below, please refer to the original Insights.
Get Straight to the Source on Smartkarma
Smartkarma supports the world’s leading investors with high-quality, timely, and actionable Insights. Subscribe now for unlimited access, or request a demo below.
When the Tender Offer / MBO for Kosaido Co Ltd (7868 JP) was announced last month, my first reaction was that this was wrong. It was couched as being management-supportive, had one large independent shareholder agreeing to tender, and the it was touted as an effort to improve the printing and other “info” businesses such as staffing, and similar.
There was no mention of the fact that 94+% of the profits the last few years came from a majority stake in an external company which conducted funeral rites and services across a well-known chain of six large funeral parlours in Tokyo. Neither that company’s name nor the business segment it operates in were mentioned in the document (Japanese only) announcing the intention to conduct the MBO and if you look on the Kosaido website, you have to dig somewhat deeply to figure out that it is even a thing. In the company’s quarterly statements and semi-annual presentations of earnings, there is one line with revenues. One has to go into the fine print of the yukashoken hokokusho to discover more, and if one does, one sees that it is the profitable funeral parlour business which is effectively being purchased at 0.5x book and the rest of the company is being purchased at 1x book.
This is a virtual asset strip in progress. It is the kind of thing which gives activist hedge funds a bad name, but when cloaked in the finery of “Private Equity”, it looks like renewal of a business.
This company is an example of why investors should be spending more time on their stewardship and the governance of their portfolio companies.
It is also why investors should be taking a very close look at the METI request for public comment on what constitutes “Fair M&A.”
It is a decent premium but an underwhelming valuation. Because of the premium, and its smallcap nature, I expect this gets done.
If deals like this start to not get done, that would be a bullish sign. Investors will finally be taking the blinders off to unfair M&A practices.
Shortly afterwards, an activist did come forward. Long-time Japan activist Yoshiaki Murakami bought 5% through his entity Reno KK, and later lifted his stake (combined with affiliates) to 9.55%. I thought the stock had run too far at that point (¥775/share). While still cheap, I did not expect Bain to lift its price by 30+% and I did not expect a white knight to arrive quickly enough. This was discussed in Kosaido: Activism Drives Price 30+% Through Terms.
The New News
In the wee hours of Monday 18 February, with 11 days left to the Tender Offer, toyokeizai.net published an article (partially paywalled) suggesting that the longstanding external auditor Mr. Nakatsuji and lead shareholder Sakurai Mie (descendent of the founder of Kosaido, who originally founded a company called 桜井謄写堂 (Sakurai Transcription) in 1949, which later became Sakurai Kosaido, then just Kosaido) were against the takeover.
THAT is interesting. And the backstory here is even more interesting.
Carlyle, along with SBI, plans to sell the rest of its stake in Aruhi Corp (7198 JP) for around US$280m.
Aruhi listed in Dec 2017, when Carlyle sold 18m shares. This is the second and final tranche of shares owned by Carlyle. The total sale accounts for 41% of the company’s outstanding shares making it a relatively large deal to digest.
However, the shares have done well since listing and the stock scores well on our framework. Valuations appear reasonable, if the company is able to achieve its mid-term targets.
The declining and ageing population in Japan has been a major cause for concern to many Japanese companies.
Fancl Corp (4921 JP), is a relatively small player in the Japanese cosmetics and nutritional supplements space who is expected to benefit from the declining and ageing population.
Compared to the peer average, EV/Sales discount narrowed down significantly over the course of the last year. But we believe the discount remains the same on a growth adjusted basis.
Still too small for institutional investors to notice. But we expect them to start noticing the company over the coming years.
One of the cheapest stocks on a long term forward multiple, as we expect FANCL to sustain its high growth over a long period of time.
We are not sure if Fancl Corp (4921 JP) can ever be in the same league as Shiseido or Kao, but we certainly believe the company doesn’t deserve to be about 10% of the size of Shiseido. Thus, we have a very long-term bullish view on FANCL and expect to see the company’s market cap to double over the next 5-7 years
On Thursday the 14th Feb 2019, Pepper Food Service (3053 JP) announced its results for FY2018 and the guidance for both 1HFY2019 and FY2019. The company managed to grow its revenue by an impressive 75.3% YoY outperforming its own estimate by 6.4%.
However, the gross profit only grew by 69.9% during the year as the gross margin slipped 137bps in FY2018 driven by higher energy prices and wages. Higher wages were due to active recruitment of foreign workers within the food service industry which created a supply shortage. To tackle increasing costs, towards the end of the year, Ikinari Steak restaurants increased the prices of its steak. We believe the margin recovery witnessed in 4Q2018 was a direct result of this price increase.
Gross Margin Showing Signs of Recovery
Source: Company Disclosures
Pepper Food Services saw its EBIT margin decline by 20bps to 6.1% in FY2018, as revenue growth offset most of the gross margin drop through gains from operating leverage. However, its restaurants in New York City continued to underperform. The company expected those restaurants to turn a corner and start contributing to the overall EBIT from FY2018, however, those restaurants failed miserably and continued to drag the overall EBIT margin down. Hence, the company failed to meet its EBIT margin forecast with EBIT falling 4.6% short of company guidance.
Musashino Bank (8336 JP) was one of the last regional banks to announce 3Q FY3/2019 results, and they were a nasty surprise: a consolidated net loss for the nine months to 31 December 2018, caused by heavy reserving in Q3 (October-December 2018) against the bank’s exposure to the troubled Akebono Brake Industry Co (7238 JP) . While the bank has slashed its full-year net profit guidance from ¥11.1 billion to ¥4.5 billion, this would still require an heroic level of profits in Q4 which the bank has never before achieved. The share price has fallen over 31% in the last twelve months. Valuations at current levels are still high (FY3/2019 PER is 17.6x) and we consider the share price to be vulnerable to further weakness. Caveat emptor (May the buyer beware) !
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