Value Investors Club / FURUBAYASHI SHIKO (3944)

Description

Overview: Furubayahi Shiko (“FS”) is a very cheap company on earnings (4.5x) and assets (35% of TBV) that should exist

in 10 years in largely similar circumstances as it does today. It has two pillars of value in that they make packaging for

consumer goods and own shares in consumer goods companies. They also have a long term track record of buying back

shares at large discounts to tangible book value. A large portion of book value is supported by an equity stake in Kao, a

high quality Japanese FMCG company. This company also exists within the Japanese backdrop of increasing focus on

returns on equity, corporate governance reform, and activism. FS has a great investment set up where it should

continue to hum along and grow TBV and generate cash, but has the potential to improve margins, increase its payout

ratio, get acquired in industry consolidation, or attract an activist to accelerate any of these options.

Valuation/Investment Setup: FS has 1,089,747 shares outstanding (1,776,820 less 686,000 in treasury) and price of

Y2,900 for a market cap of Y3.16bn, which at USDJY 108 is $29.2m. FS should still generate a high single digit return at

worst even if most of the cash doesn’t get returned to shareholders, the market doesn’t reward a higher multiple to the

business, or there is a cyclical downturn (if such a thing still exists).

At 9/30/19 there was Y1,431bn of cash, Y5,120bn of investment securities, Y710bn of ST debt, Y761bn of current long

term loans payable, and Y1,115bn of LT debt, and Y2,297bn unrealized gains on securities. That is Y6,551bn of gross

liquid assets, Y2,586bn of debt. Net of Y735m of tax on the unrealized gains and the debt, there is Y3,230m of noncore

net financial assets, which is the whole market cap. Tangible book value is Y9,072m, 3x the current market cap.

Adding back Y110m of interest and investment incomes gives FY19 core business net income of Y356m. If the core

business is worth 5-10x earnings, that is Y1.7-3.56bn. Combined with the cash pile, the market value should be 50-100%

higher. I do not know the proper multiple. Interest rates are so low in Japan that 10x seems fair given that on one hand

the outlook for revenue is just ok, but on the other 1000bps over the benchmark for a resilient cash flow stream seems

harsh in today’s world. The return on net tangible assets [EBIT/(NWC+PP&E)] has averaged 4.7% since FY08, but got up

to 6.9% in FY19. If it continues to improve, which it has in FY20, it would justify a multiple closer to 10 than 5.

FY20 is shaping out to be even better, with H1 revenue up 21% and EBIT up 106%. Taking out interest and investment

income, H1 net income was Y341m. This improvement being the new normal or even a midway point to greater success

in the future is just gravy on top of the existing trailing earnings and asset value.

Historical Activity: A very rightful concern is that despite a cheap valuation on earnings and assets, management may

never do anything to exploit the valuation gap. FS has actually steadily repurchased shares over the past decade, evem

prior to Abenomics. The company had 1.77m shares outstanding in March 2008. Today they have 1.09m shares

outstanding, a 38% reduction. Is this the next NVR, CHTR, or AZO? Is Henry Singleton-san reincarnated as the CEO of

FS? Probably not, but they repurchased shares in FY09, 10, 12, 13, 15, 16, and 17 spending a total of Y955m. This was

~25% of cumulative CFO-Capex over that period. All at dirt cheap valuations. I cannot speak to management’s future

intentions, but I will make the general observation that past behavior can be indicative of future behavior, in which case

management has a fairly long track record of repurchasing shares in size and across time.

Business: FS makes packaging for a variety of FMCG products. They also make the packaging equipment for customers.

I view them as generating revenue from what are generally steady end markets and possessing a fair degree of customer

intimacy from selling the equipment alongside with the packaging products to secure ongoing business. As margins

indicate, this isn’t a massive competitive advantage that allows them tremendous returns, but it does indicate that

forward looking results should at least demonstrate a degree of consistency. I believe these characteristics are very

valuable and an attractive mitigant within the context of an investment in a Japanese nanocap with known unknowns.

Their largest customer is Kao, which has historically represented about 20% of revenue. Kao sells products like laundry

detergent, soaps, and diapers. FS has no other major customers, but based on their equity portfolio, which is for

“business relationships,” other customers serve equally resilient end markets. Meiji and Ezaki Glico both make

confectionary products. Okamoto makes condoms and a selection of small ticket consumer products. Taisho

Pharmaceutical makes OTC pharma products.

The business is still run by the founding Furubayashi family. People with the last name Furubayashi own 117k shares,

about 10% of the company.

Earnings Power: This will focus on the core earnings power of the packaging business, as they get a good chunk of net

income from their securities portfolio. My forward looking hypothesis is that because the end markets of FS’s customers

are consistent, FS should have consistent earnings power going forward. This hypothesis is bolstered by the company’s

track record going back to FY08, where the company has an average EBIT margin of 3% through FY19. Their worst year

was FY12, when operating margin was 1.6% with FY08 peak revenue troughing in FY12, a cumulative drop of 11%. So

the business held up pretty well in a variety of circumstances such as $100+ oil, the Tohoku earthquake, and the GFC.

Revenue has been pretty flat. FY19 had revenue of Y16.797m and 11 year average revenue has been Y16,457m with a

high of Y17,071m and a low of Y15,185m. Japan has a declining population, which will not help going forward, but there

will probably not be a step change in consumption patterns of soap, diapers, and laundry detergent (if these are famous

last words, the future is going to stink). On the plus side, FS has some Chinese operations which could counteract the

persistent headwind from Japan. Revenue from China, before intersegment eliminations, increased from Y2,920m in

FY11 to Y4,582m in FY19, although it peaked at Y5,199m FY14, so over time it has gone in the right direction.

FY19 was a good year with 4.1% EBIT margins. One can interpret this as a sign of impending reversion to the mean or a

breakout from the trend. H1 FY20 EBIT margins are up to 6%, although this appears to be driven in a good part by

operating leverage on strong revenue growth rather than a core improvement in operations, but I do not know which

way revenue goes from here. It is possible the company has some underlying initiatives which are increasing efficiency

or they could be shedding some unprofitable business, both of which are encouraged by Abenomics.

EBITDA margin has averaged 6.8% since FY08. Capex has historically been lumpy, but has averaged 3.1% of revenue, so

EBITDA-Capex has averaged 3.7%, so 4.1% EBIT margins are a tad high, but not overly concerning. Capex should be

higher in FY20 as they are spending Y630m on a factory relocation in their Shanghai Kobayashi subsidiary, of which they

own 60%, so they should be on the hook for Y378m of that, which is in addition to regular capex.

The company owns 100% of its Japanese operations, but its Chinese operations have been JV’s, giving rise to some

minority income. They own 80% of their Taiwan business, 60% of one Shanghai JV and 70% of another in China. EBIT

margins in the Japanese segment have been increasing since FY11, when they started to break out segment margins,

while Chinese ones have been declining. Pressure on Chinese margins has been driven in part by increases in labor rates

per their filings. This seems supported by the Chinese operation employing 332 employees compared to 317 in Japan as

of FY19, even though Japanese revenue is 2.5x Chinese revenue. The recent annual report mentions increasing focus on

“mechanization efforts.” While not mentioned in the same place, perhaps part of the aforementioned factory relocation

includes updating the production to be less labor intensive and more productive. This would likely make the Chinese

operations more competitive and should help return it to growth and increase profitability.

Balance Sheet

FS owns 491,000 shares of Kao and 79,400 shares of Meiji. They own a selection of other shares as well, but these

represent the bulk of the value, as the third largest holding is worth just a shade over Y100m. As of early December

2019, the Kao stake is worth Y4.25bn and Meiji stake is worth Y600m.

FS has one of the more attractive set ups compared to other Japanese companies due to its overcapitalized balance

being in the equity in a high quality company instead of JGB’s or a random grab bag of average companies. I don’t

understand what’s going to happen with Japans debt/GDP ratio or negative interest rates, and luckily with FS I don’t

need to pretend I do. This is in contrast to many low-to-none EV companies in Japan only serving the domestic market

where one might fret they are exposing themselves to twice the hyperinflation risk as both the assets and the earnings

are in nominal figures that don’t adjust to inflation. In the case of Kao retaining a durable value, I will venture that the

consumption patterns of soap and diapers will remain fairly consistent regardless of the medium of exchange absent

Comrade Maduro replacing Shinzo Abe as Japan’s leader.

The Kao stake generates Y64 of dividend income at current rates, and Kao has raised their dividend every year for 29

years. In FY19, FS paid Y23 interest on Y3,537 of average debt. I don’t think the company intentionally created a

leveraged position in Kao, but it is still a nice piece of financial engineering. Most importantly, for the debt to be a

problem both Kao’s dividend would need to turn off, the core packaging business would have to really go to shit, and

they’d have to set fire to their cash.

Miscellaneous: This is cheap because it is a boring nanocap in Japan. If one wanted to venture further, it also does not

screen well for the people who are interested in statistically cheap Japanese names. It screens as having net debt

because the investments aren’t picked up. Further, it isn’t obvious the investments are actually high quality CPG

companies and not JGB’s without opening the annual filing.

Conclusion: Seems cheap. Improving underlying operations appear to be going unnoticed. Historical repurchase activity

unappreciated.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Time, further repurchases, activism, Abenomics continuing, consolidation.

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			2019	2020
Price:	2,940.00	EPS	625	0
Shares Out. (in M):	1	P/E	4.5	0
Market Cap (in $M):	30	P/FCF	0	0
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT	0	0