Daily Industrials: Horiba (6856 JP): Bad News Largely Discounted and more

In this briefing:

1. Horiba (6856 JP): Bad News Largely Discounted
2. EM Relative Strength Is Bottoming: Overweight
3. FamilyMart: A Shrewd Head-Fake?
4. FamilyMart Tender Offer for Don Quijote Misses The Mark as Mr. Partridge Stands Pat
5. CJ Corp Share Class: Huge Net Gain Difference Between Common & Pref from Stock Dividend

1. Horiba (6856 JP): Bad News Largely Discounted

Horiba combines high gearing to semiconductor capital spending with a large and growing automotive test business characterized by upward trending but uneven profitability. At ¥4,545 (Friday, December 21, closing price), its share price has dropped by 53% from an all-time high of ¥9,590 reached last May. Falling demand for semiconductor production equipment and a downward revision to FY Dec-18 sales and profit guidance announced in November appear to be largely in the price. 

The downward revision, which cut projected full-year operating profit growth from 15.5% to 2.5%, followed a 22.2% year-on-year decline in operating profit in 3Q and implies a similar rate of decline in 4Q. The weakness is concentrated in Semiconductor Equipment and Automotive Test, the former due to a cyclical downturn in overall demand, the latter due to M&A-related and other one-time expenses. New Automotive Test orders continued to outpace sales, leading to a 9.5% increase in the order backlog during 3Q.

Automotive Test sales and profits should rise next year, while semiconductor equipment sales and profits seem likely to bottom out. In a report issued on December 17, SEMI (the semiconductor equipment and materials industry organization) forecasts a further decline in wafer fab equipment sales in 1H of 2019, followed by recovery in 2H. Other industry sources we talked to before the report was issued had similar views. 

This scenario could fall apart due to general economic weakness, American attempts to stifle China’s semiconductor industry, or both. On December 21, Reuters reported that Foxconn “…is in the final stages of talks with the local government of the Chinese city of Zhuhai to build a chip plant there with a total investment of about $9 billion… most of which would be shouldered by the Zhuhai government through subsidies and tax breaks…” This looks like a perfect target for the Americans, but whether or not they will notice or care remains to be seen.

Horiba is now selling at 9.6x our EPS estimate for this fiscal year, 13.4x our estimate for next year and 12.1x our estimate for FY Dec-20. These and other projected valuations are near the bottom of their 5-year historical ranges. If the Semiconductor Equipment division does not recover in 2H of 2019, historical data suggest that its operating profit could drop by 70% rather than the 47% we are now forecasting, resulting in a P/E ratio of 17x. Nevertheless, it is time to start considering when and at what price to buy Horiba.

2. EM Relative Strength Is Bottoming: Overweight

Relative strength for MSCI EM is bottoming vs. MSCI EAFE despite continued global equity market weakness.  Although the MSCI EM’s price index remains in a downtrend, we are seeing signs of outperformance ona a relative strength basis and would add incremental exposure. In this report we highlight attractive and actionable themes within EM.

3. FamilyMart: A Shrewd Head-Fake?

We think the failed tender but continued asset sale between Familymart Uny (8028 JP) and Don Quijote (7532 JP)  is astutely beneficial for Familymart Uny Holdings (8028 JP) and parent Itochu Corp (8001 JP) . More details below 

4. FamilyMart Tender Offer for Don Quijote Misses The Mark as Mr. Partridge Stands Pat

In October, the Nikkei leaked and Familymart Uny Holdings (8028 JP) immediately thereafter announced that Familymart would sell the rest of its GMS (and financing) subsidiary UNY to Don Quijote Holdings (7532 JP) (which bought 40% of the company in 2017) and would conduct a Tender Offer later in 2018 at a 20% premium to the then-current price to buy a stake in Don Quijote of just over 20%. The Tender Offer was announced November 6th. Familymart had arranged to borrow shares it did not manage to buy in the tender so that at the next record date it will have 20% of the voting rights by hook or by crook. 

Don Quijote shares jumped to the Tender Offer price the same day and then spent a day there before investors decided that the news and structure of the deal was better news for Don Quijote than Familymart had priced in. 

Results of the Tender Offer have just been announced. Familymart had been trying to buy 32,108,700 shares for JPY 212 billion. They just missed. They got 0.08% of the total desired, or 24,721 shares for just over JPY 163 million.

THEY GOT NOTHING.

I expect Familymart had zero idea this would happen. I expect their bankers are surprised as well. They should not have been. They analysed this badly. There was a decent chance they would find it difficult to dislodge shares from owners. 

In FamilyMart Tender for Don Quijote – Elmer vs Mr. Partridge? I recalled how “Old Turkey” (from Edwin Lefevre’s Reminiscences of a Stock Operator) did not want to lose his position while Elmer was eager to take profits.

“I couldn’t think of selling that stock.” “You couldn’t?” asked Elmer, beginning to look doubtful himself. It is a habit with most tip givers to be tip takers. “Why not?” And Elmer drew nearer. “Why, this is a bull market!” The old fellow said it as though he had given a long and detailed explanation. 

Growth stock managers don’t like selling growth stocks until the growth stops growing. Don Quijote is still growing. And with UNY, Don Quijote may grow faster than previously expected. 

The announcement at the end of the Tender Offer Results announcement is also VERY telling. There was a plan to make Don Quijote an equity-method affiliate by buying in the Tender Offer, buying in the market, or borrowing lots of shares. There was a plan for Familymart to appoint directors to DQ.

There was a clearly-available trading strategy based on that. 

The new announcement puts that strategy into question. And Mr. Partridge might not be so inclined to call it a bull market. Since the launch of the deal, the markets have started the trip to Gehenna in a trug. From the one-month average prior to the Familymart bid news, Don Quijote is up 25%. Familymart is up 40%, the Nikkei 225 is down 10.7%, the TOPIX retail sector is down 5.5% but Familymart and Don Quijote have influenced that performance (without those two names, average performance is worse).

5. CJ Corp Share Class: Huge Net Gain Difference Between Common & Pref from Stock Dividend

• CJ Corp (001040 KS) announced a 0.15 stock dividend. CJ will issue a new class B pref. Both Common and Pref will get 0.15 class B pref shares for each share they already own. This new class B pref is convertible to Common with a 10 year duration. It gives an extra 2% of the face value to what Common gets. A total 4,226,513 new class B prefs will be issued.
• CJ previously had two class B prefs. Based on the historic discount % of these two, 2P’s discount to Common on the listing day is estimated at 33%. There will be nearly 10% price dilution in both Common and 1P. There will be a 10+%p difference in gain per share. 1P’s dilution-adjusted net gain per share stands at 13.61%, whereas Common is only 0.66%.
• Price ratio wise, 1P is in an undervalued territory. On a longer horizon, it is currently close to the 2Y mean. This stock dividend should push 1P further upward above the 2Y mean. CJ also said that it would give cash dividend. Current div yield difference is a historic high at 1.53%p. This should be another reason to push up 1P. I’d go long 1P and short Common at this point.