Description

DESCRIPTION

C. Uyemura is a Japanese company with a strong market position in producing and selling electroplating chemicals, an attractive niche within the surface treatment of PWB/PKG’s (electronic components). The company delivers high-end products at high margins to Japanese companies that are suppliers to manufacturers of smartphones, cars, servers/PC’s, consumer electronics and appliances.

The core business is attractive with long-term growth potential, high switching costs, high operating margins and high returns on capital.

For more background on the company, we recommend the excellent write-up from TrojansFightOn from September 2016.

The stock has performed well but we believe it is still attractively valued at EV/EBITDA 4,5 based on FY March 2018 guidance that will likely be beaten. The value is obscured by a listing on the 2nd section of the Tokyo Stock Exchange, other low-margin businesses and excess assets.

BUSINESS

C.Uyemura’s businesses comprise the following 4 segments:

1/ Surface finishing/treatment chemicals

2/ Surface finishing/treatment machinery

3/ Plating jobs

4/ Real estate leasing

1/ Surface finishing/treatment chemicals

This segment represents more than 75% of revenues and in excess of 90% of operating profits. It combines plating chemicals sales and chemicals trading. The company does not disclose the profitability for the sub-segments but told us that chemicals trading is a 5% margin business that in recent years broke-even. We see the value of C.Uyemura’s operating business therefore being determined by the sales of plating chemicals and we will provide more details on this activity below. The segment margins increased in recent years as sales of chemicals trading declined and plating chemicals increased.

2/ Surface finishing/treatment machinery

The company describes the surface treatment machine business as akin to printers & ink whereby the low-margin sale of machines ensures high-margin recurring sales of materials. C.Uyemura sells approx. 80% of the materials needed by customers who have installed their machines and these sales represent approx. 50% of all materials sold.

Over the medium-term management hopes to generate JPY 4-5bn in sales at a 10% margin in this segment. For the period 3/2015 to 3/2017, this segment suffered losses because of cost-overruns as they struggled to meet the high specification requirements of a US semiconductor customer. For the current FY 3/2018 this segment has returned to profitability as these costs were absorbed in previous years.

3/ Plating jobs

Plating jobs are the plating with metal of plastic components, mainly car components.

This segment generates JPY4.7bn in sales and is currently loss-making because of a sluggish economy in Thailand and losses at their plant in Indonesia; a recently added factory that is still ramping up production. Management believes losses in Indonesia, currently at JPY 365ml, will not increase and they hope to become profitable by 2021.

4/ Real estate leasing

The company’s non-core real estate leasing business consists of 1 office building in Shin-Osaka that represents more than 90% of the market value, with the balance consisting of individual condominiums. This building used to be C.Uyemura’s old factory which was converted into an office building in 2003.

The property portfolio generates JPY 520ml in EBITDA and the last valuation the company provided was in the annual report of 2016 at JPY 8.1bn. This valuation seems reasonable considering the EBITDA it generates, combined with a strong property market in Osaka.

PLATING CHEMICALS

Over the period 2011 to 2018 (based on guidance), surface treatment chemicals generated JPY 45bn of operating profits on total profits of JPY 44bn excl. real estate. Machinery generated JPY 1.5bn losses and plating jobs were more or less break-even over the same period.

Chemicals trading is a 5% margin business that has recently operated at break-even levels. Therefore, plating chemicals are the key to understanding C.Uyemura’s earnings power.

For FY 3/2018, C.Uyemura expects to generate JPY 26.8bn sales of plating chemicals: chemicals for HDD (5,4%), chemicals for PWB/PKG (77%), conventional electroless nickel (7,8%) and others (9,6%). We notice that C.Uyemura generates the vast majority of its profits from the sale of chemicals for PWB/PKG.

Plating enables an item to make use of the electric and magnetic properties of a metal. It is used for example in PCBs, wiring, connections, electronic components, connectors and semiconductors.

Plating of PWB/PKG is done in 4 stages:

1/ Produce the foundation with electroless copper plating necessary in order to conduct the electricity

2/ Produce the wiring with electrolytic copper plating

3/ Produce a barrier layer with electroless nickel plating to prevent the diffusion that occurs when gold is plated directly on the surface of copper

4/ Produce an anti-corrosion layer with electroless gold plating

C.Uyemura specialises in gold and nickel plating, and focuses on the most valuable stages of the plating process (stage 3 and 4).

The competitive landscape has been stable with no new entrants for many years.  Globally there are Atotech and Dow Chemical Company, locally there are three other Japanese players: JCU Corp (TSE:4975), Japan Pure Chemical Co Ltd (TSE:4973) and MEC. Competitive pressures are low as C.Uyemura focuses on Japanese companies, both in Japan and abroad, and specialises in specific metals. C.Uyemura claims to be substantially larger in the high-end segment compared to its competitors.

Typical contracts take two years to negotiate and client relationships are very long-term despite annual price reviews. These long-term relationships are most pronounced in the car industry. C.Uyemura started a cooperation with Toyota Motor Company over ten years ago for the coating of power control units for their hybrid cars. Because of driver safety issues, these negotiations and R&D were a ten-year process as opposed to two years for smartphones. IR told us these investments are important and it is crucial to be first because once you get the contract, the relationship with the client stays for life.

The client base is diversified with the largest client representing <5% of sales.

During the crisis, sales dropped from JPY 25bn to JPY 16.6bn and are currently JPY 26.8bn. Smartphones represent 70% of plating chemical sales for PWB/PKG and cars and Internet of Things (IoT) are still much smaller businesses. Cars and IoT are long-term growth markets, but the growth rate for smartphones is already declining. However, miniaturization and higher functionality support the demand for the higher-end services C.Uyemura provides.

Assuming that the trading activity breaks-even, then the EBIT margin for plating chemical sales is 27% with a historical range of 20% (2009) and 28% (2015). Margins remained high during the GFC because of limited pricing pressure. Plating chemicals are a mission-critical component that represents a small percentage of the overall customer manufacturing cost.

MANAGEMENT & CAPITAL ALLOCATION

Mr Hiroya Uyemura is CEO and owns 25% of the company. The dividend pay-out ratio is about 25% and the focus is on operations and on growing the company. The last five years CapEx has been relatively high with the construction of a factory and a new R&D facility. IR told us that they expect CapEx in the next few years to be lower, probably around JPY 2bn per year, as the company has no major CapEx plans. CapEx for the current FY is expected to be JPY 5.5bn. While management did a fine job at running the company, it is clear a lot of value for shareholders remains locked. In typical old-school Japanese style, the company has kept excess cash on the balance sheet and further diluted a highly profitable business by investing in real estate. We do not see immediate change on the horizon and believe the current valuation compensates us sufficiently.

VALUATION

The M-Cap is JPY 74bn and EV is JPY 40.4bn.

We value the real estate investments at JPY 8.1bn, the BV is JPY 2.3bn and the latent tax liability JPY 1.8bn assuming a corporate tax rate of 32,26%. Our valuation is based on the latest market value estimates provided by the company in the 2016 annual report. For 2017, C.Uyemura reported JPY 721ml revenue from real estate leasing implying a cap-rate of 8,9% at our valuation.

Cash and ST Investments are JPY 31bn of which JPY 17bn is in Chinese and Taiwanese subsidiaries. For the calculation of Enterprise Value, we assumed a 15% Withholding Tax to repatriate these funds to Japan and deducted the estimated CapEx planned for Q4 2018.

Adjusted for real estate investments and net excess cash the shares are trading at 8,1X 2017 adjusted earnings (excl. leasing) and 8,5x 2018 guidance. Based on Run Rate earnings for the first nine months of FY 3/2018 the multiple drops to 7,8x. To meet guidance, Q4 must be a weak quarter. IR told us that they expect a strong quarter and seasonality supports H2 with smartphone releases. It seems likely that the company will do better than guidance.

RISKS

-       Cyclical downturn

-       Technological risk in not being able to meet ever increasing technical requirements

-       Pricing pressure in low-end sector

Catalyst

- Better than expected results for FY 3/2018

- Continuing growth of plating chemical sales

- Normalization of profits for surface treatment machinery

- The factory in Indonesia scaling up and reaching profitability

- Improved cash flow generation as CapEx declines