Description

I believe Mitsubishi Logisnext (“Logisnext”) is a very attractive special situation (equity stub) where upside is a multiple of the downside. It carries the characteristics of successful equity stubs described in the books “You Can Be A Stock Market Genius” and “The Manual of Ideas”: improving fundamentals & cash generation, “good kind” of leverage and good incentives.

* EV is high due to a 10-year bullet loan from the parent company. Bank debt is actually quite low at 1.4x EBITDA.

* Years adjusted: FY2017 = year ended March 2018
** Estimates are cash earnings & therefore exclude goodwill amortization

Logisnext is the 3rd largest forklift manufacturer in the world, 2nd largest in Japan and is trading at a large discount to my estimate of intrinsic value for several good reasons:

1. it results from the merger of several businesses which didn’t exist under their actual form until recently, or which saw several name or perimeter changes in the last few years and where privately held
2. it is a pure player with a small market cap, still under the radar of international investors (they own < 10% of the shares)
3. there is no serious sell-side coverage, as the stock is listed in Japan and the market cap is too small
4. The stock is not screening well (P/E18 of 30 according to Bloomberg which has some numbers wrong, most valuation ratios appear high)
5. Japanese GAAP requires goodwill amortization, which makes the P&L a very bad proxy for cash generation. Logisnext having quadrupled its size via acquisitions in the last few years, the amortization charge is so large that EBIT is half of EBITA, furthering point 4 above
6. The company, being very busy with the latest merger integration, has no IR department and did not accept investors request until last month. A conference call is unlikely to work, thus you will need to visit the headquarters in Kyoto.

The firm has a large potential for post-merger integrations and the parent company Mitsubishi Heavy Industries (“MHI”), currently in the middle of a large restructuring & reorganization of its business, is working at a fast-pace to improve its subsidiary’s results. I see a large upside, partly due to operating margins which could almost double in the next few years. Even without taking this improvement into account, Logisnext is still the cheapest forklift manufacturer in the world on several metrics.

Today, the company’s brands are: Nichiyu, Mitsubishi, CAT Lift Trucks (Caterpillar), Rocla, Unicarriers, TCM, Atlet, Barrett, and Jungheinrich just for the US market.

Apologies for the length, the several reorganizations make keeping this writeup brief a tough task...

I - History of the firm & recent acquisitions

II - The Unicarriers deal

III - Market

IV - Financials and discussion of margins

V - Valuation and catalysts

VI - Other comments

I - History of the firm & recent acquisitions

What is Logisnext today started a long time ago as Nippon Yusoki, one of the oldest forklift manufacturers in Japan. It is their original business contrarily to Toyota Industries (“TICO”) which is now market leader but started in the textile loom business. Nippon Yusoki has forever had a long-track record of innovation: they developed the first electric forklift in Japan (in 1939 !), the world’s first automatically guided forklift (“AGF”) in 1971, the first automatically guided vehicle (“AGV”) resistant to explosions, etc. Through the years they became specialists of electric forklifts with a great distribution network in their own country. They developed slowly but safely until reaching 83B JPY in net sales in 2012 (~760M$ at today’s rate), 90% of which were in Japan. They changed name along the road, becoming Nichiyu Electric Forklift (“Nichiyu”).

In 2013, they follow the consolidation of the sector and merge their forklift business with the forklift business of MHI, one of the largest industrial firms in the country. MHI then goes from 20% to ~49% ownership, and the firm changes its name to Mitsubishi Nichiyu Forklift (“MNF”). This merger is important as sales go from 83B JPY to 206B JPY. With this, they acquired a larger product line (with the addition of the internal combustion (“ICE”) forklifts from MHI) and a large geographical diversification (the part of sales done outside of Japan went from 10% to 50%, because MHI’s business was so far very focused on Europe & North America. They also get benefits from associating with a larger industrial group with experience and contacts.

In 2015, MHI and MNF continue their adventure and announce together the acquisition of Unicarriers. First, MHI acquired the majority of the business, but then sold it back to MNF afterwards. This deal will again almost double consolidated sales.

In October 2017, once the consolidation effective, MNF changed its name to Mitsubishi Logisnext - I hope for the sake of clarity this is the last time.

II - The Unicarriers deal

Some time must be spent on the latest deal, which created the “special situation”. I will dive in the financials in part 4.

Unicarriers is a private company formed in 2012 with the merger of the forklift division of Nissan Motor and Toyo Carriers Manufacturing, TCM, then owned by Hitachi Construction. Nissan Motor’s forklift division was a multinational business, which developed by acquisitions, buying US firm Barret in 1988 and Swedish firm Atlet in 2007. They all unified under the Unicarriers group, with the capital owned in majority by the Innovation Network Corporation of Japan (“INCJ”), then by Nissan Motor and Hitachi Construction. The INCJ is a government-affiliated fund supervised by the Japanese government, whose goal is to basically promote Japan’s business interests.

We know Unicarriers is an asset with a great value and great potential for synergies, because KION, number 2 worldwide, also tried to acquire it in 2015 to increase its reach, notably in the US. The bad luck for them is that the Japanese government was involved (through INCJ), and very likely preferred to sell to a Japanese player. The reason is unlikely to be the price, because it was sold to the Japanese players at roughly the same price bid by KION (see in part 4).

That’s a lot of moving parts and different name changes in a short time. Some details about he Unicarriers deal are important:

The arguments for the acquisition of Unicarriers are:

• finish the completion of the product line-up
• gain in scale, critical with regards to the sector’s consolidation
• profit from the complementary of the distribution networks of the two firms

→ Being an industrial business with large fixed costs, synergies to be derived from this operation are potentially (very) large.

This acquisition is finalized at the beginning of 2016, and is first made at 65% by MHI, and at 35% by MNF, so consolidated in the accounts of MHI and as an equity-method affiliate in the accounts of MNF. At the end of 2016, MNF announced its decision to increase its share in Unicarriers at 100%, which at the time went largely unnoticed by the market. MHI sold its 65% stake to its subsidiary at the same price at which they bought it barely a year earlier, and lent them the full amount to buy it. At the same time, they increased their share in MNF to >50% of the capital and >63% of the voting rights, to maintain control. As shareholders of Logisnext, we are essentially shareholders of the publicly traded portion of this LBO. The acquisition is fully debt-financed, by the parent company, who is also the seller. All this at a close to 0% rate with no principal repayment for 10 years (in sum, a bullet loan).

This situation can be surprising, however note the following. MHI is in the middle of a business restructuring and wants to integrate the 2 firms as quickly as possible. Second, with this operation they increase their reported sales (deconsolidation of Unicarriers but consolidation of the MNF + Unicarriers merged entity), which will help them reach their mid-term plan targets.

A schema of the 2-steps of the acquisition helps:

The fact that this consolidation happened at the beginning of 2017, means that Logisnext did not yet report a full year of consolidated accounts, which is partly why this interesting situation exists, I believe.

III - Market

After these successive acquisitions, Logisnext is now positioned as the 3rd forklift manufacturer in the world. It is very interesting as most ranking available did not adjust for the merger until very recently (one reliable ranking is the Modern Materials Handling ranking published yearly on www.mmh.com).

* listed company
** external source for the data, firms estimate may differ, for instance Logisnext estimates its market share at slightly above 10%. Another way to cross-check is to look at market share by units, which yield similar conclusions: Logisnext will produce 115k units this year for a yearly market estimated at 1160k units worldwide (WITS estimates), yielding 10% market share worldwide

*** calculations using today’s exchange rate, your estimates may differ

With regards to sales the consolidated entity now has 42% of sales in Japan and 58% of sales internationally, of which a large part come from USA and Europe, although they are active in several other countries. They are quite active in Thailand, their first Asean market, they are also present in China etc.

Local market shares are great, they now have a 35% market share in Japan, behind TICO (45%). This is a great sign for profitability, as the market is now essentially becoming a duopoly. Our contact with TICO suggests they also see this consolidation as a positive for their forklift business. In Europe, they have 10% market share. In China, they have 4-5% market share, slowly increasing. I do not have exact market share data for other countries, although consider:
- hey bought back Finnish firm Rocla Oy in 2008, 3rd AGV manufacturer in the world which is a leader in Scandinavian countries
- in the US, they have some presence through the sale of Jungheinrich products, commonly accepted as one of the best-in-class manufacturer of electric forklifts. Unicarriers is also known for its strong US position.

This suggest Logisnext is well positioned in all of its markets.

The forklift market being quite cyclical, you may wonder where we stand in the cycle. In Japan, the market is without excess and in slight decline (-0.5% p.a.) but growing for the electric forklifts:

Given that the market is very mature, one can probably expect 30-50% of sales from consumables, although this is a wild guess. The trend in Japan is very promising, as the consolidation of the market between the two big players TICO & Logisnext happens concurrently to 3 interesting trends:

• the labor shortage in Japan is at a multi-decades low, and firms are struggling hard to recruit new employees. This is a big tailwind for automation demand and AGVs, as productivity improvements become more and more critical. One can look at the charts of “automation stocks” to understand the hopes of the market on this trend.
• the strong increase in e-commerce is a driver for forklift demand and storage automation system. It is estimated that for the same dollar of sales, an e-commerce warehouse requires 3x the space compared to a traditional brick-and-mortar warehouse.
• Tokyo 2020 and its large construction projects may be expected to increase demand for large forklifts

These factors can reasonably be estimated to drive a healthy growth for the next few years.

International markets look more toppish. Looking at the WITS orders data:

US market is expected to fall a few percent this year, in consolidated terms. The long-term trend is that internal combustion engine forklifts are decreasing and electric ones are increasing. However, Logisnext seems quite confident it can grow its sales there judging by their recent growth capex in the US (they increased production capacity by 40% for electric forklifts). Secondly, the growth of warehouse automation and e-commerce, as for Japan, is expected to drive growth going forward.

IV - Financials and discussion of margins

We only have limited financial information on Unicarriers because the firm was not listed, here is the public data collected from the Japanese filings and the price paid by Logisnext:

*118,148 = 76,777M sale price for the 65% stake + 30M JPY of estimated advisory expenses

So it seems the deal was done at an attractive price, yet pricing in some synergies. Secondly, the remaining stake was sold by the parent to Logisnext at roughly the same price as it bought it for, and roughly the same price KION would have paid, rumored to have bid 100B JPY.

With this information I estimated pro-forma accounts, which can be adjusted with recent Q1 and Q2 publications.

The remarquable point of the consolidated entity is the weak operating margin for the business. OPM is <4%, meanwhile a normative margin for a great forklift manufacturer is in the 7-9% range.

→ Why is this so ?

Logisnext in its actual state is the consolidation of several companies which were never optimized to work together. MNF and MHI were working 10 years ago via sales agreement (Nichiyu was providing MHI with electric forklifts to sell them with MHI’s distribution network, and conversely, MHI was providing Nichiyu with ICE forklifts to use their very good Japanese distribution network).

1. Although the merger leading to the creation of MNF happened, synergies have been slow to materialize, including technology development and sales network integration. It seems the firm lacked a strong impulsion to change, which was maybe a management problem.
2. Unicarriers, which was just added to the perimeter, is itself a firm created in 2012, where there are still several integrations to do with TCM & Nissan.
3. The consolidation of Unicarriers added 65B JPY of goodwill (~600M$) which is amortized under JGAAP and lowers OPM.

→ How will the margin improve ?

Principally via cost-cutting, which is reassuring, sales synergies are not the center of the thesis here. The firm will focus on the integration of the production sites of MNF and Unicarriers, to increase their utilization rate, which should lower fixed costs by 10%. Some production sites will thus be closed. Moreover, they will dedicate some sites to unique models to increase efficiency.

In a communique released by the ministry of Energy, Trade and Industry (“METI”) approving the restructuring, one learns that the firms plans to increase value-added per employee by 25% since 2020. Being in Japan, the restructuring will not include any layoffs.

Furthermore, part of the margin-improvement is expected to come from additional scale on raw material purchases. These type of synergies will be the quickest to implement. In an article in the Kyoto newspaper, one executive of the firm declared that these synergies would show “starting from the second half of the year” (and the first judge of this will be Q3 publication in a few days).

→ Why believe in the margin improvement story ?

1. The parent MHI has an ambitious mid-term plan and is doing what is needs to do to get there. Logisnext is not negligible as it is one of their largest business and represents 10% of their sales.
2. Several management changes where made at the executive and board level. The CEO of Logisnext is a former MHI executive and also became CEO of Unicarriers. Executive have been granted Logisnext’s stock option, although the amount is still limited. Top executives also include former Unicarriers members in charge of R&D and post-merger integration. It makes sense.
3. MHI’s presentations indicate that the restructuring is going well
4. The level of details given in the presentations is high. This is quite unusual for Japanese firms which tend to not communicate much and give margin objectives that can seem unreachable, without giving details about where the improvement may come from.
5. The new market structure in Japan as well as the efforts put in until now make reaching 7% OPM very probable.

V - Valuation

On the basis of these elements, valuation looks very attractive. Here are elements of a few relatively comparable companies:

* my cash estimates for Logisnext, Bloomberg 17E numbers for other firms
** Hyster-Yale margins & ratios are depressed due to their Nuvera Fuel Cell bet which is still loss making

In my forecasts, I aim for a 6% EBITA margin in FY 2018-2020 vs. the management’s forecasts which is 7%. I am more conservative because it is possible that part of the cost structure improvement will be given back to clients in the form of price discounts. Whether you look at EV/Sales, EV/EBITDA, P/E, you are trading at a discount to peers while this is not justified by the quality of the asset, the margin potential improvement, and the fact that organic growth is higher than peers.

Using a blend of peer mutliples, I arrive at a fair value between 2,000-2,000 JPY per share.

VI - Other comments and risks

Several ideas come to mind with regards to risks.

- MHI is now the majority shareholder of Logisnext, therefore an obvious risk would be being bought back by the parent at an unfair price or a stock-for-stock merger with an unfair exchange ratio. 3 facts are mitigating this risk. First of all, I did not find for MHI a track record of unfair dealing with minority shareholders, contrarily to some other large Japanese groups. Second, the price at which they sold the stake to Logisnext was very fair, because Logisnext bought the stake roughly at the same price than that at which MHI bought a year earlier. This would have been a possible occasion to profit from minority shareholders, which they didn’t take. Third, Logisnext is the only firm I know of in Japan which profits from an almost-free loan from its parent company under great conditions. The normal practice in Japan is the contrary: as a minority shareholder of a large group’s subsidiary, your cash is parked at the parent company and you’re paid a measly return, and you usually cannot do much. Some activists have been involved recently against this practice.

- The firm looks very indebted. However, the bank debt is actually quite low. The executive team is aware of this, saying: “in Japan we have 0% interest rates. It’s better to have a loan via our parent company which is a very large group, and use its financing capabilities as much as possible”. Another signal that management is ok with the debt is that they kept on paying their dividend this year, in the country with the most overcapitalized balance sheets in the world.

- Logisnext may need to play catch-up with other forklift players in terms of automation solutions for warehouses. They are already involved in automation but recent acquisitions by competitors Toyota Industries and KION are raising the bar. The trend is to proceed to acquisitions to complete one’s offer and stay in direct contact with clients / create value from your connections / sell some software.  It is unclear how they are going to develop more their offering there and if MHI will help them for the next acquisitions. It is my understanding the current integration is already a large work-in-progress and will keep them very busy for some time.

- The value of the distribution network of Logisnext is validated by the fact that it’s the group chosen by Jungheinrich for the exclusive distribution in North America since 2010. At that time they closed their operations in the US and delegated all distribution and maintenance to Logisnext. This is excellent because it shows the quality of Logisnext which is chosen by one of the best actors in electric forklifts worldwide, and that electric forklifts are a growing segment principally due to environmental norms.

Catalyst

- progress on the cost-cutting and on post-merger integration (PMI)

- better visibility on the new business with the publication of Q3 results beginning of February and FY results in April

- initiation of coverage by a broker, and start of IR activities by the firm. With the size of the company increasing, I believe we will get there rather sooner than later.

- shift to IFRS, as is the trend for other Japanese firms, would cancel goodwill amortization and make reported profitability more in-line with true-cash generation

- the Abe government is currently working on introducing tax breaks for companies doing large capex, this would be a double gain for Logisnext: it would both strongly increase demands for its products, and lower its own tax bills with the capex planned for its post-merger integration activites