Description

Nippo is a Japanese leader in construction and material production for the road paving industry.  The company primarily produces, designs, and installs surfaces for highways, airports, bridges, and other civil works.  Nippo produces asphalt for both its own consumption and for external sale.  The company also has a general construction business, focused on small projects, which makes up ~15% of operating profits, while the core road paving business accounts for ~85%. 

Nippo is a good business that operates in an attractive industry.  Nippo is the largest participant in the market with ~25% share, while the top seven companies comprise ~75% of the road paving industry.  Because of their size, the larger market players have a cost advantage comprised of raw material purchasing power, lower transportation costs, and greater fixed cost absorption due to elevated utilization rates.  Asphalt mixture needs to be used while hot, so local market density is important because the product can only be transported within two-to-three hours of the plant.  This challenge, along with Nippo’s cost advantage, keeps smaller mom-and-pop players from trying to underprice projects and has resulted in Nippo generating a 10%+ return on tangible capital.     

Infrastructure in Japan is aging, as the country realized a boom and peak in public works spending throughout the 1980’s and 1990’s.  Nearly 70% of the bridges and 60% of the tunnels in the country are more than 20 years old.  I expect low-to-mid single digit sales growth for the road paving industry over the medium-to-longer-term.  My view is based on estimated spend for the toll road companies (which comprise ~60% of the country’s road paving expenditures), the national government (~20% of spend), and municipalities (also about 20%).  In fact, roadway repair spending for the five toll road companies in Japan has grown at a high-single-digit rate for the past ten years. 

Nippo trades at 7.8x 2020 (Ending March) EPS but has about 40% of its market cap in net cash and liquid securities.  When adjusted for this, the stock trades at just 4.5x.  While the company does pay a dividend (~20% payout ratio) and trades at a 2.2% dividend yield, I believe Nippo’s balance sheet is overcapitalized. Although Nippo has not yet initiated a share buyback program, there is growing pressure on Japanese companies to return capital to shareholders and repurchases within the Japanese market have become more prevalent.  That said, I am attracted to Nippo’s investment discipline and note that they have not allocated meaningful capital outside of their core road paving operations.  Furthermore, the stock has good balance sheet support, as it trades at 0.65x tangible book value and at just a 4% premium to its liquid assets less all liabilities (see below).  Lastly, I believe Nippo owns valuable property in Tokyo that is conservatively marked (see below).  Although it is unlikely that Nippo will monetize this asset, I think it provides an additional margin of safety.  Nippo has compounded its earnings at a rate of 13% per year over the past 15 years and we expect it to continue growing its EPS at a double-digit rate.  I see about 120% upside for the stock.  

Balance Sheet

It’s rare to find a classic Ben Graham “net-net” stock these days, but Nippo is about as close as I’ve seen recently.  The company has cash of 47b yen, other current assets of 269b yen, and liquid marketable securities of 46b, offset by total liabilites of 152b yen.  That’s 210b yen of net liquid assets or 1,764 yen per share.  That provides downside support of just 4% below the current price of 1,835 yen per share. 

Tokyo Real Estate

On the balance sheet, I think there is a potential hidden asset, which I believe is a free option.  The company owns a building (its headquarters) and land of 7,000 square meters near Tokyo Station and the Imperial Palace.  In Japan, land is the only item that counts as property value on the balance sheet because, after 20 years, buildings are depreciated to zero value.

This property is booked at just 1.9b yen.  But, my market value estimate of this property is about 109b yen.  This assessment is based on a market rate of 15.5m yen per square meter (using values for this address from the Tax Office database).  This unrecognized value of about 100b yen is equal to about 50% of market cap.

Of course, unless the company is willing to monetize this asset, it may remain hidden but still protects the downside of the investment, in my opinion. One possibility for them is to transact a sale and leaseback or lease part of the headquarters to other businesses as an office property. 

Catalyst

Continued cash generation. Possibly a buyback or special dividend.