Description

Thesis

Fuji Machine Mfg. Co., Ltd. (Fuji) makes machines which place surface mount semi-conductors on printed circuit boards (surface mounters); they also make metal cutting lathes. They have the largest share (globally) for high-speed surface mounters and consistently generate cash.  At ¥1,127 per share, Fuji may be purchased for less than the value of their current assets (net of all liabilities) and about 7.5x trailing earnings. Adjusting for their over-capitalized balance sheet by subtracting 90% of the company’s cash from its market capitalization, Fuji is selling for 2.4x trailing earnings and 5.9x fully taxed free cash flow.

 The following table summarizes Fuji’s current valuation and capital structure.

 The table indicates that cash and securities represent 103% of Fuji’s current market capitalization (92% when netted against their debt). Also note that Fuji’s current dividend yield is 3.1%, higher than the current yield on 30-year Japanese government bonds (2.0%). Fuji’s dividend policy is very conservative, i.e., dividends represent a small fraction of cash generated.

While its historical cash generation is cyclical, Fuji consistently generates cash (2004 being the exception, please see table at the top of page one) and in some years, copious amounts of cash in relation to its enterprise value. The combination of such a modest valuation, overcapitalized balance sheet and solid historical performance leads one to wonder if the company’s future prospects are bleak – this doesn’t appear to be the case.  

FY 2013 forecast: earnings up

The following table summarizes Fuji’s historical revenue and earnings and includes management’s forecast for the current fiscal year ending 3/31/2013.

Fuji’s Historical Earnings and Forecast 

The data in the table indicate that Fuji’s management expects the current fiscal year to be better than fiscal 2012, i.e., Fuji is trading at less than 7x 2013 earnings. (Fuji Machine Mfg. Co, Ltd., Kessan Tanshin (summary financial statement release), 3/31/12, PDF p. 31).

Qualitative aspects of Fuji’s business: solid business

Fuji operates in two segments defined by the two types of equipment they make: high-speed surface mounters and metal turning lathes (see below for a description of each). The following table summarizes EBIT generated from these two segments since 2000.

Segment EBIT

The data in the table indicate that Fuji typically makes money from its surface mounter business and typically loses money from its lathe business. Surface mounters are machines which place electronic components on printed circuit boards; surface mounters are typically purchased by electronic manufacturing services such as Flextronics International Ltd. (FLEX) and Hon Hai Precision Industry Co. Ltd. (2317 on the Taiwan Stock Exchange). Lathes are machines on which a work-piece is turned on its axis while being cut; Fuji sells lathes primarily to Japanese auto companies.

Surface mounters last ten years or more, however, because electronic components are continuously made smaller and increasing numbers of components are mounted on a printed circuit board, electronic manufacturing services typically replace their surface mounters every four years to keep pace with competitors. Currently, the smallest chips in use measure 0.4 mm by 0.2 mm; traditional cell phones have about 400 components on their printed circuit boards while smart phones have about 800 components.  Increasing numbers of smaller components plays to Fuji’s expertise - the trend is their friend. The following table shows the current market share of high-speed surface mounter manufacturers.

2012 Market Share: High Speed Surface Mounters

Depending on configuration, Fuji’s latest surface mounter, the NXT II, costs about ¥45 million ($560,000). Here are the geographic markets Fuji served in FY 2012; as one would expect, the vast majority of their sales (73% during 2012) are to customers in Asia.

FY 2012 Geographic Markets Served

Fuji’s sales tend to be concentrated among a few customers; during the last two years they generated about 30% of their revenue from two customers.

Fuji Customer Concentration

Fuji sells surface mounters through a network of distributors except in Japan, where they sell directly to end-users. So far we have established that Fuji is very modestly valued based on historical and forecast earnings and that they generate their earnings from a business which, while cyclical, is critical to the way the world works (efficiently placing increasing numbers of ever smaller chips on printed circuit boards).  Fuji also appears to be the leader in this business on a global basis, e.g., it generates cash from this and has the leading market share. The two negatives we have found are:

• They have a customer concentration issue - we suspect this is the nature of their surface mounter business (they have only disclosed two years of data regarding customer concentration). 

• Historically, they tend to lose money in their lathe business.  

This leaves the issue of their over-capitalized balance sheet. With so much cash, how are the company’s returns on capital?  The following table summarizes Fuji’s returns since 2000.

Fuji capital returns, no adjustments

The table shows that Fuji’s after tax return on equity averaged between 6 and 8% during the last five years – while this is not great, its not bad for a business that is so overcapitalized.  The table on the next page shows the capital returns after reducing Fuji’s cash and securities by 90%, providing us with an estimate of the returns the business actually generates without the heavy cash burden.

Fuji capital returns, assume cash & securities balances reduced by 90%

Using this method, Fuji produced a return on equity of 11 – 16 % over the last five years, respectable but not outstanding.

Conclusion

Fuji is not a perfect business – it is subject to the vagaries of the capital spending habits of electronic manufacturing services, an industry linked to global demand for electronic devices. Mitigating this is the observation that demand for smaller and more capable electronic devices is not likely to abate. The company’s future performance is also reliant on its ability to continue to make more capable surface mounters than its competitors (Panasonic and ASM International) – if past is prologue, they should remain in good shape. Fuji’s management has chosen to retain a very large portion of the company’s cash flow and, as a result, the business features an overcapitalized balance sheet – while this is not endearing, things could be worse, e.g., they could have squandered the cash on dilutive acquisitions. Fuji is currently valued at 0.7x its net current assets plus securities less all liabilities, a valuation which implies management is likely to destroy the business’s value.  We can find no evidence that management is destroying value – to the contrary, the company consistently pays a dividend and increases its book value (see chart below). The combination of cheap valuation and consistent value creation leads us to conclude that Fuji shares represent a bargain at ¥1,127.

Cash flow summary

Catalyst