Brief Equities Bottom-Up: Mercari: Why Mercari Is Likely to Be a Winner in the Cashless Wars and more

In this briefing:

1. Mercari: Why Mercari Is Likely to Be a Winner in the Cashless Wars
2. Notes from the Silk Road: Xtep Int’l Holdings (1368 HK): Time to Run (Away) For Now
3. Angang Steel: PMI Recovery to Support Shares: Close Short
4. Optex (6914 JP): Factory Automation Slowdown in the Price
5. Sumco: Well Positioned to Expand Capacity Faster than Its Competitors if Demand Picks Up

1. Mercari: Why Mercari Is Likely to Be a Winner in the Cashless Wars

While we have been sceptical about Mercari Inc (4385 JP)‘s efforts in the US, we have always appreciated the domestic business and have only been put off by the rather demanding multiples. After speaking to the company, we continue to like the domestic business and feel that recent initiatives to broaden the user base are likely to be successful. In addition, while we still feel that there are numerous question marks about whether the business model can work in the US, we have come around to a more positive view on the company’s execution there. Lastly, we believe Merpay’s edge in the cashless wars is underappreciated and the fall in the share price is starting to make the stock attractive.

We discuss the details below.

2. Notes from the Silk Road: Xtep Int’l Holdings (1368 HK): Time to Run (Away) For Now

Xtep International (1368 HK) has announced a placing and top-up subscription of new shares event, creating a capital base which is 9% larger. 

XTEP states that they have considered various ways of raising funds and consider that it would be in their best interests to raise equity funding through the placing and the subscription. 

With the share price down 16% since the placement, we examine what this means for the company’s fundamentals and shareholders. We believe the results will prove to be mixed for management and shareholders alike. We highlight how we expect the stock ranking to react, given we the placement was only a few days back and this is yet to reflect. This special situation analysis may surprise you with the conclusions.

3. Angang Steel: PMI Recovery to Support Shares: Close Short

INVESTMENT VIEW:
The recovery in China’s March PMI index to 50.8 shows an unexpected expansion in economic activity.  Historically, there is a strong correlation between the PMI and Chinese steel prices as well as Angang’s share price. 

We close our short on Angang Steel Co Ltd (H) (347 HK) shares. 

4. Optex (6914 JP): Factory Automation Slowdown in the Price

According to management, weak demand for factory automation sensors had a significant negative impact on sales and profits in 1Q of FY Dec-19. Also, in our estimation, it is likely to cause 1H results to fall short of guidance. But this should be in the share price, which has dropped by nearly 50% from its 52-week high. 

In the year to December 2018, operating profit was up only 2.1% on a 7.0% increase in sales, largely due to an increase in machine vision marketing expenses. In January and February 2019, factory automation orders and sales dropped abruptly as customers sought to reduce excess inventories. In March, some new orders were received for delivery in May, indicating that the situation may stabilize in 2H. Demand for security and automatic door sensors continues to grow at low single-digit rates.

For FY Dec-19 as a whole, management is guiding for a 6.2% increase in operating profit on a 7.2% increase in sales. Our forecast is for flat operating profit on a 2% increase in sales. Sales and profit growth should pick up over the following two years, in our estimation, but remain in single digits.

At ¥1,765 (Friday, March 29, closing price), Optex is selling at 18x our EPS estimate for FY Dec-19 and 17x our estimate for FY Dec-20. Over the past 5 years, the P/E has ranged from 13x to 36x. On a trailing 12-month basis, Japan Analytics calculates 5% upside to a no-growth valuation, which is in line with our forecast for this fiscal year. This suggests: buy either for the bounce or for the long term. 

5. Sumco: Well Positioned to Expand Capacity Faster than Its Competitors if Demand Picks Up

• The semiconductor silicon wafer market saw continued growth in demand for all wafer diameters supported by applications for servers, data centers, automobiles and IoT applications.
• While the demand for semiconductors, data centers and other IoT applications are declining, Sumco expects firm demand from power semiconductors, sensors and automotive uses. The management expects the demand from the 5G market also to aid in top-line growth.
• Sumco has posted an extraordinary loss following the early termination of a long-term polysilicon purchasing agreement. The long-term contract with Osaka Titanium is expected to end in March 2019. We expect this move to help Sumco switch to cheaper polysilicon which in turn should help reduce costs. That being said, some of the long-term contracts for polysilicon are still continuing, and there is still significant inventory built-up so this impact could take four to five years to be fully realised.
• Having visited the company recently, Sumco still has more potential brownfield capacity available, which we believe can be used in the event the demand picks up enabling the company to add new capacity faster than its competitors and enjoy the benefits from growing demand and increasing prices.