Nittoc Write-up
Nittoc Construction Co (1929 JP) is a small cap civil engineering company which we believe presents
investors with an asymmetric opportunity to piggyback off of the efforts of Strategic Capital, a Japanese
activist firm, to unlock value at a highly cash generative company with a lazy balance sheet. Unlike a lot
of activist campaigns in Japan which have gone nowhere (see
https://www.wsj.com/articles/SB10001424127887324216004578482943175923954), Strategic has
already successfully helped convince management to raise the company’s payout from 30% to 50%+, as
was announced last month as part of Nittoc’s 3-year plan presentation to the market. Even though the
shares have rallied post the announcement, we may only be in the early innings of the capital return
story at Nittoc as raising the payout closer to 100% and returning the excess cash on the balance sheet
could lead to a 2-3x appreciation in the stock price. Meanwhile, the downside is well protected by an
implied 3.5% dividend yield, 1.1x P/B valuation, and cash balance equal to ½ the market cap. Given that
Nittoc is only a $226mn market cap company and has no sell-side coverage, we think it will take several
months before the market wakes up to the story.
As is highlighted in this article (https://www.bloomberg.com/news/articles/2017-05-24/japan-activist-
seeks-to-triple-assets-after-flying-start-to-year), Strategic is not afraid to be direct and even
confrontational with management in order to promote good corporate governance and capital
allocation. While there are many “cheap” companies in Japan like Nittoc, Strategic built up a 5% stake in
the company in late 2016 encouraged by the fact that Nittoc’s major shareholder is the family of the
Finance Minister Aso, so it could be an issue if the government is preaching against cash hoarding (see
https://www.ft.com/content/60315d7e-cbd1-11e4-beca-00144feab7de?mhq5j=e2) while the Finance
Minister’s own family company is not taking the right steps. We’ve met with management of Nittoc on
several occasions (both before and after May’s 3-year plan announcement) and found them to be
consistently receptive to continuing to improve their shareholder return policy. Given these dynamics,
we believe further improvement in Nittoc’s shareholder return policy is entirely plausible.
Nittoc is a civil engineering firm specializing in slope protection and land improvement. It works on
hundreds of projects simultaneously (therefore there is limited project concentration risk) and most of
its profits come from slope protection, where it is the number 2 player in a niche dominated by two
companies which own 2/3 of the market. Nittoc argues that their main competitive advantages are that
their core slope protection IP is patent-protected and that they have a long-track record in the space. An
independent check with a general contractor which subcontracts to Nittoc confirmed that there is
indeed real IP in slope protection. To gauge this, we plotted Nittoc’s historical adjusted ROEs over the
last cycle (we define adjusted ROE as operating cashflow minus depreciation divided by equity minus
excess cash). One would expect a company with a moat to consistently earn an ROE in excess of COE
(which in Japan is in the mid to high single digits given where interest rates have been). Although