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CERTAIN STATEMENTS [KR1] CONTAINED HEREIN REFLECT THE OPINION OF THE AUTHOR AS OF THE DATE WRITTEN. NO INVESTMENT DECISIONS SHOULD BE BASED IN ANY MANNER ON THE INFORMATION AND OPINIONS SET FORTH IN THIS REPORT.  YOU SHOULD VERIFY ALL CLAIMS, DO YOUR OWN DUE DILIGENCE AND/OR SEEK ADVICE FROM YOUR OWN PROFESSIONAL ADVISOR(S) AND CONSIDER THE INVESTMENT OBJECTIVES AND RISKS AND YOUR OWN NEEDS AND GOALS BEFORE INVESTING IN ANY SECURITIES MENTIONED. Please see additional Important Disclaimers at the end of this analysis.

I will try get through this writeup without making a single untasteful joke or bad pun.

Okamoto Industries, Inc. (“Okamoto”) is the manufacturer of Japan’s #1 condom brand, with a particular focus on the premium end of the market, and I believe holds a top 3 share globally.  Why do we care about condoms?  Well Australian based Ansell sold its Sexual Wellness business back in 2016 for USD600m, which was 3.1x revenue and 15.8x EBITDA.  Reckitt Benckiser bought SSL (Durex) in July 2010 for 17.6x EBITDA.  Sagami Rubber (5194), a Japanese competitor, is currently valued at a mid-teens multiple of EBIT.  

Why the high multiples? Well it turns out selling branded rubber generates rather attractive margins and return on capital.  As an example, Sagami generated a 21% margin during the pandemic impacted fiscal year ending 3/31/2021, and Ansell’s historically generated an EBITDA margin of circa 20%.  Brand matters because you don’t impress anyone by purchasing the cheapest product on offer, and there is real downside from a faulty product. 

As for Okamoto, the company happens to produce what they proclaim is the world’s thinnest condom, which as you can see from Amazon or other sites is generally regarded as about as good as it gets if you require protection.  On the rare occasion when I lucky enough to have use for the product it is my go to brand, and I have never found anything to complain about.

AmazonSmile: OKAMOTO 004 Condoms, 24 count, White, 4738: Health & Personal Care

The 4 Best Condoms 2021 | Reviews by Wirecutter (nytimes.com)

Interestingly, the Okamoto brand is actually very well known in China, a country in which the company holds a leading position in the premium market – so much so that counterfeiters illegally sell Okamoto fakes.

Chinese police break up US$7m counterfeit condom gang that sold dangerous fakes under Durex and Okamoto brand names | South China Morning Post (scmp.com)

I don't have hard data on China, but the Former Global Director, Consumer Insights, Health Wellness and Transformation at Reckitt Benckiser recently stated “the next big ones then, not in terms of volume but much so in terms of value, are definitely Okamoto, initially from Japan but I guess now the biggest in China…..when I was still in the business, the growth rate, the value growth for Okamoto, was around 20-30% during these years. They were really growing quite strongly from a 3% global share to a 7% global share, with a very limited footprint in terms of geographies, but, of course, if you’re in China that means, yes, you’re only in one country, but you are getting to quite a sizeable portion of the world population”.

While small markets, Okamoto also has meaningful condom positions in other parts of Asia, including Hong Kong, Singapore, Thailand and Taiwan.  Okamoto’s condom business is part of the company’s household products division.  Over the past five fiscal years (March year-end) the household product division delivered the following performance:

Now the household products segment includes some other products in addition to condoms.  In some of the products, such as dehumidifiers, the company holds a leading position, and others, like rubber garden shoes the product is somewhat undifferentiated.  From my conversations with management, I believe condoms account for roughly a third of segment revenue and well over half of segment profits.  I should also add 2020 revenues were negatively impacted by flooding at the company’s Fukushima plant that knocked out 5-10% of production, while fiscal year 03/21 was obviously hurt by the pandemic.

Going forward the biz is probably rather stable within Japan, with potential for overseas growth.  I don’t have exact figures for what portion of division sales come from overseas, but my sense from speaking with management over the years is that it is not wildly different from the 25% ROW generated at the company level.

So what is the household segment worth?  Based on where peers trade and private market transactions involving other leading condom brands over the years referenced earlier, I think perhaps 12.5x EBIT and ~18.0x p/e seems reasonable (assumes 30% corp tax rate which is line with historical average).  The segment is worth less than a pureplay condom company, but it is hard to find any FMCG with leading positions and attractive economics in developed markets that trade much lower than this.  You basically have a premium brand that will grow on the back of rising incomes across China and parts of SE Asia.  This gets us to a value of Y81.0bn by applying the suggested multiples to 2021 pandemic impacted operating profit.  That’s equal to the market cap using the treasury adjusted number of outstanding shares.

So what’s the upside you ask?  Well, you also get a nichey industrial segment that in a normal world should do about Y6.0bn (USD600m) with a normalized EBIT margin of around 6-8%. The average margin over the past five years was 7.7%, but I feel more comfortable suggesting the low end of 6% going forward despite recent investments in automation and efficiency.

オカモト株式会社 (okamoto-inc.jp)

The business is basically a hodge podge of products that are exposed to GDP growth type industries, such as auto, construction, food wrap, etc.  As an example, the company makes the coatings that repel water from the seats of Honda Motorcycles when it rains.  I will suggest this segment is worth about 6.0x normal EBIT of Y3.6bn, or Y21.6bn. FWIW avg EBIT over past five years was Y4.3bn, and the company has made significant investments to expand capacity over the past few years.  

OK, so if you think household is worth the market cap as suggested earlier, the industrial segment gives you potential upside of Y21.6bn, or ~25%.  But of course this is Japan, so you also have a net cash and equivalent position equal to Y38.6bn even after deducting for retirement liability, deferred tax, and debt.  The cash and equivalents alone get you another ~50% of the market cap.

But we’re not done.  The company also owns real estate that consistently generates roughly Y420m a year in pre-tax income.  I cap it at 5.0% yield that contributes another 10% of the market cap.  I included this in the cash figure in the net debt figure of the statistics section of th writeup, but exclude the rental profit from EBIT as it falls below the line.

As for capital allocation, I actually don’t think they are bad guys.  The controlling family seems to be thrifty and value conscious.  They pay a dividend that gets you a 2.3% yield that was growing at a DD CAGR for the five years pre Covid 19. They also tend to buyback shares opportunistically, which has historically translated to around 2-3%/yr reduction in share count if you exclude the period where the shares were getting punchy and they held back.  So you get a return of capital of circa 5% a year while buying a headline valuation that is circa 4.0x LTM EBIT.

Before I sign off, I will add there are about Y2.0bn annual corporate costs that I have not accounted for in the sum of the parts, but did get picked up in the quoted EV/EBIT multiple.  There is also about Y150-200m of regularly recurring affiliate income that I ignored so as to not complicate matters.  Basically you can slice and dice the valuation any which way, or just look at the headline numbers and it will be cheap no matter what your preference if you are into these kind of things. If you aren’t, well no price is cheap enough so it really don’t matter.

My compliance office said we have to disclose risks before we can go to print.  I tried to explain the business trades at 4.0x a conservative estimate of EBIT, but that didn’t hold water.  So please take note that the company’s earnings could decline due to increased competition, the stock may never go up, and Japan is prone to flooding and earthquakes.

Important Disclaimers

The provision of this report does not constitute (and should not be construed as) a recommendation, financial promotion, investment advice, encouragement or solicitation to buy, sell, or hold the security of the subject issuer (the “Security”), or any other securities, discussed herein. This report is for informational purposes only. All of the information contained herein is based on publicly available information with respect to the security and the author’s analysis of such information. Past performance is no guarantee, nor is it indicative, of future results.

Certain statements reflect the opinions of the author as of the date written, may be forward-looking and/or based on current expectations, projections, and/or information currently available. The author cannot assure future results and disclaims any obligation to update or alter any statistical data and/or references thereto, as well as any forward-looking statements, whether as a result of new information, future events, or otherwise. Such statements/information may not be accurate over the long-term. The views are those of the author acting in his individual capacity and not as a representative of the firm.  The author’s opinions on this Security may change at any time in the future and the author will not, and disclaims any obligation to, update this report to reflect any change in opinion. The author further disclaims any obligation to respond to any comments or questions posted regarding the Security discussed herein.

NO INVESTMENT DECISIONS SHOULD BE BASED IN ANY MANNER ON THE INFORMATION AND OPINIONS SET FORTH IN THIS REPORT.  YOU SHOULD VERIFY ALL CLAIMS, DO YOUR OWN DUE DILIGENCE AND/OR SEEK ADVICE FROM YOUR OWN PROFESSIONAL ADVISOR(S) AND CONSIDER THE INVESTMENT OBJECTIVES AND RISKS AND YOUR OWN NEEDS AND GOALS BEFORE INVESTING IN ANY SECURITIES MENTIONED. AN INVESTMENT IN THE SECURITY DOES NOT GUARANTEE A POSITIVE RETURN AS STOCKS ARE SUBJECT TO MARKET RISKS, INCLUDING THE POTENTIAL LOSS OF PRINCIPAL.

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Catalyst

High margin consumer business obscured by lower margin industrial business

No catalyst on the horizon but you get a dividend and management regularly buys back stock

Valuation is reasonable on multiple levels

Recently began posting English language financials on the website...can that count as a catalyst?