Nittoc Construction 1929
June 13, 2017 - 2:11am EST by
2017 2018
Price: 587.00 EPS 0 0
Shares Out. (in M): 44 P/E 0 0
Market Cap (in $M): 234 P/FCF 0 0
Net Debt (in $M): -129 EBIT 0 0
TEV (in $M): 106 TEV/EBIT 0 0

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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, 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 (
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 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
Nittoc’s adjusted ROEs have been choppy, the historical financials do suggest the presence of at least a
weak moat and that Nittoc should be valued at least at 1x P/B and, arguably, at a premium to book
An important risk to flag is that both orders and margins may be peaking for the company and the
Japanese construction sector, more broadly. Nittoc’s gross margins have expanded by 300-400bps over
the last 3 years, but Nittoc’s main competitor in the slope protection industry, Raito Kogyo (1926 JP),
and Japanese general contractors (e.g. Taisei, 1801 JP) experienced similar magnitudes of margin
expansion. The chart below summarizes Nittoc’s outlook for the demand backdrop and is fairly
representative of the expectation across the sell-side: 2-3 years of steady demand followed by a drop-
off as the benefits of investments ahead of the Olympics and recovery/rebuild from the Fukushima
disaster and Kumamoto earthquake fade away. (See consensus estimates and research on Raito and
Taisei for evidence of this.) Given this industry dynamic, we believe it’s important to consider Nittoc’s
relative valuation when evaluating whether the stock is mis-priced.
For now, the company is showing no signs of slowing down its order book is up 17% YoY. While
Nittoc’s management is guiding for net profit to decline MSD YoY for YE March 2018 (which we
conservatively use for our dividend estimates below), they have a long track record of beating guidance.
For instance, Nittoc exceeded 2013 OP guidance by 23%, 2014 OP guidance by 53%, 2015 OP guidance
by 68%, 2016 OP guidance by 5%, and 2017 OP guidance by 35%. This suggests to us that Nittoc is likely
to exceed its YE Mar 2018 guidance as well.
As mentioned above, in May, Nittoc announced it’s 3-year plan where it raised the target payout from a
minimum of 30% to a minimum of 50%, of which at least 30% will be from dividends. (The company is
also planning a FY 18 dividend of at least 21/share, which includes a 30% dividend payout and an
anniversary dividend of 6/share.) Nittoc has since been in the market executing its repurchase plan.
As can be seen below, in the context of a yield-hungry Japan, Nittoc’s current share price is well
supported given the current policy. In a downside scenario, perhaps the market prices Nittoc at a 40%
payout ratio (giving partial credit to a buyback) which equates to a 3.5% dividend yield. Then, if one
penalizes Nittoc’s dividend yield by 100bps because it is a small-cap (and has historically traded a c.
100% bps dividend yield premium to comps) this results in a 2.5% yield, which appears well underpinned
relative to the Topix Small Cap index and the comps below.
Nittoc’s downside protection is also supported on a P/B basis. A 1.1x P/B, the stock is well within its
normal historical trading window and, as mentioned above, such a valuation is justified on the basis of
its long-term return history. (Of course, it should be noted that there is 30% downside to its trough
valuation on P/B although the stock has historically quickly bounced back from such levels.)
Finally, 1.1x P/B is at a discount to the Topix Small-Cap index and doesn’t appear out of line versus
comps based on P/B versus ROE.
The bull case for Nittoc, however, is that we are only in the early innings of its capital return story. Given
the involvement of Strategic Capital, the shareholder ownership dynamic, and Nittoc management’s
demonstrated openness to improving capital return, it would not be shocking to see Nittoc improve its
payout closer to 100%. At an 80% dividend payout, the current stock price would imply a 7.1%, which
could lead to a doubling of the share price based on where the comps are trading. Moreover, the
company also has c. 6bn Yen of excess cash (the business only requires 1.5x one month of sales to be on
hand as cash) and the management openly tells investors in meetings that this excess cash will be
deployed into either M&A or returned to shareholders. This could put total shareholder return close to a


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.



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