In this briefing:
- Repsol, Petronas & Mitsui Make Massive Gas Find in Indonesia
- What’s Down with Muji (7453 JP)?
- Free Money Has Flown
- Komatsu, HCM, CAT: The Stock Punishment Does Not Match the Outlook Deterioration Crime
- Kosaido TOB (7868 JP) Situation Gets Weird – Activists and Independent Opposition to an MBO.
1. Repsol, Petronas & Mitsui Make Massive Gas Find in Indonesia
Repsol SA (REP SM)‘s discovery is very significant for the companies involved and others around the area, which we discuss in detail below. It is also important for Indonesia, which requires more gas to supply domestic and export demand. It is also positive for exploration sentiment globally, to see a material discovery (Oil Exploration: We Expect a Resurgence in 2019 Pointing to Strong Performance for E&Ps) and this may encourage further M&A in Indonesia such as this deal: (Indonesia Upstream Gas Asset Sale: Positive Read-Through to Other SE Asia Gas Companies).
2. What’s Down with Muji (7453 JP)?
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.
3. Free Money Has Flown
The world will soon discover that debt matters.
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.
4. Komatsu, HCM, CAT: The Stock Punishment Does Not Match the Outlook Deterioration Crime
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% |
5. Kosaido TOB (7868 JP) Situation Gets Weird – Activists and Independent Opposition to an MBO.
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.
I published my original opinion in Smallcap Kosaido (7868 JP) Tender Offer: Wrong Price But Whaddya Gonna Do? suggesting that the only way this was likely to not get done is if some brave activist came forward. I concluded…
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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