Description

Hitachi Zosen Fukui (6163, “HZF”) is a nicely profitable company trading right at tangible book value with a smart activist who has recently gotten involved.  While there are plenty of cheap stocks in Japan, and this is illiquid so likely only for small funds and personal accounts, it is rare to find the trio of 1) a good company, 2) a dirt cheap valuation, and 3) a smart activist involved.  This has all of those characteristics and appears highly asymmetric as a result. 

Overview

Razor99 recommended HZF in May of 2013 and did a good job describing the business so I’ll keep the overview brief and recommend you read that for background (https://www.valueinvestorsclub.com/idea/Hitachi_Zosen_Fukui/99697#description).  Razor99 did an ever better job recommending when to sell, as the stock rose from 935/share to 3,100/share less than a year after the write-up and he or she literally top ticked the “exit recommendation”.  Since then the business has continued to perform nicely while the stock has come back down, trading at similar valuation levels to the 2013 write-up and with the added new bonus of an activist investor, Cornwall Capital, now owning 13% of the company and likely pushing for additional shareholder friendly actions: 

HZF makes automated press machines and other equipment for Japanese auto makers.  For example, a few months ago Honda started using a new laser cutting method to produce its body panel parts and they worked with HZF to developed the new method.  From Automotive News Europe:

“The method improves previous laser cutting technologies by achieving speeds necessary for mass production. It is 10 times faster than previous laser methods, Honda says, enabling it to cut tens of thousands of panels a day.”  (03/15/2016)

Today HZF trades for less than 7 times earnings, has an average ROE over the past five years of ~16% and has increased its dividend multiple times in recent years (currently 3.4%).  Downside appears limited given it trades right at tangible book value with over 80% of the current market cap in cash and securities.  Cornwall’s recent involvement makes this particularly interesting in my opinion, decreasing the odds of this becoming a value trap and increasing the odds of a highly accretive buyback or other shareholder friendly move, so it’s worth taking a close look at who they are, what they are likely doing behind the scenes at HZF, and whether they are likely to be successful. 

Cornwall Capital

Cornwall was launched in 2003 by Jamie Mai as a family office after his father, Vincent Mai, had considerable success running private equity firm AEA Investors.  Cornwall has a great track record and is focused on finding mispriced, asymmetric investments across asset classes.  If you’ve read or seen The Big Short, they were one of the funds profiled who made a killing betting against subprime mortgages.  In the last few years Cornwall has gotten more involved in Japan, even raising a separate fund to take advantage of the opportunity.  Some additional publicly available background on Cornwall and their activities in Japan:

"…between January 2003 and April 2011, Cornwall Capital achieved a compound annual return of 42.5% net for its investors. The old fund closed down in April 2011 and a new fund; the Cornwall Master Fund has continued on its legacy achieving compound annual returns of 4.1% net since May 2011.” (July 5, 2016 - link to source at the bottom)

“…I’m part of a fund called Cornwall Capital.  Cornwall Capital doesn’t fit neatly into any of the traditional hedge fund buckets.  We look for asymmetric situations by trying to identify market inefficiencies across all asset class.  That usually involves buying options though at times we buy outright equities that have option-like characteristics.” (Spring 2012 - link to source at the bottom)

“Cornwall’s investment objective with respect to the Japan Master-Feeder entities is to generate attractive risk-adjusted absolute returns by acquiring substantial ownership interests in Japanese companies that are perceived to be profitable and high-quality, at steep discounts to intrinsic value. The target companies are generally expected to be market leaders in their sectors, generating steady cash flows, with limited debt, large amounts of excess unencumbered cash and other liquid assets, and low valuations. This opportunity seems significantly more interesting now than it has been in the past, due to several factors, including evolving attitudes in Japan toward corporate governance, capital allocation, and institutional investor engagement that are spurred by ongoing structural changes. Discussions with portfolio companies are expected to be conducted in a constructive, rather than confrontational, manner with the help of a team of experienced local advisors and may include advice oncapital allocation and balance sheet management, advice on investor relations, and, in some situations, advice for a management or parent-led buyout.” (March 1, 2016) 

“JC de Swaan, a principal at Cornwall Capital, says this is the best time in recent years for value investing in Japan. He notes that many Japanese companies have net cash holdings equivalent to more than 50% of their market capitalizations, and an increasing number of firms are moving to improve their capital efficiency by raising dividends and repurchasing stock.” (June 12, 2014 - link to source at the bottom)

While there is a long list of investors who have tried and failed with regards to activism in Japan, the situations that get the most attention are typically those where the investor is publicly hostile towards the company and management (TCI, Third Point, etc.).  While those get most of the attention and have not had a great success rate, there are a number of lesser known “friendly activists” in Japan who have had considerable success working behind the scenes with management teams to improve corporate governance and capital allocation.  It’s clear that this is Cornwall’s approach as well.

Cornwall also seems to have had success with this approach thus far.  According to local regulatory filings, Cornwall has bought large stakes in three other stocks in Japan.  One, Hirano Tecseed (6245), they sold within six months after the stock rose more than 20% after they filed on it.  The other two have each increased their dividend and announced buybacks since Cornwall got involved:

·         SNT Corporation (6319)

o   Cornwall position first disclosed: May 2014

o   Increased its dividend in 2015

o   Announced first share buyback in February 2016

·         Agro-Kanesho (4955)

o   Cornwall position first disclosed: December 2014

o   Increased its dividend in 2015

o   Announced first share buyback in March 2016

While nothing is certain, the combination of 1) Cornwall’s great track record generally, 2) their sensible approach and clear intent to improve capital allocation with Japanese companies, and 3) the fact that their other holdings in Japan have recently initiated buybacks, provides a reasonable probability that we’ll see a buyback or some other sort of shareholder friendly move here as well.  For what it’s worth Cornwall has continued to buy additional shares of HZF in recent months – another local filing that was just released shows that they were buying almost every day the market was open between May 23^rd and July 19^th.  

Summary 

Overall this appears like a highly asymmetric situation.  The major risk is that HZF is exposed to cyclical auto-related spending – the short-term could therefore be bumpy and the company is projecting a slight decrease in sales and income over the next year.  An investment in HZF stock is also exposed to the Yen, although their end buyers (auto exporters) typically prosper when the Yen falls which provides a partial hedge.  Finally, Cornwall’s activism may not work and cash could continue to pile up on the balance sheet and not be put to better use.  With all of these risks you are still protected by the cash and asset value on the downside, and since this is a good company at a very cheap valuation there seem to be many ways to win. 

Links and additional information:

http://www.valuewalk.com/2016/07/cornwall-capital-letter/

http://www.adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=360946

https://issuu.com/princetoncfc/docs/financier-spring12/10

http://asia.nikkei.com/Markets/Tokyo-Market/Foreign-investors-eye-cash-rich-Japanese-stocks

http://www.wsj.com/articles/jc-de-swaan-shinzo-abes-quiet-breakthrough-1401295001

http://europe.autonews.com/article/20160315/COPY/303159974/honda:-laser-cutting-saves-time-money

Company presentation: http://www.h-f.co.jp/english/files/lib/3/92/201606201013109546.pdf

Catalyst

-Increased dividends

-Share repurchases

-Continued cash generation