Description

Showa Paxxs Corporation (3954:Tokyo)

Certain statements 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.

Intro [1]

Japan has long been a land of simple businesses with asset rich balance sheets trading at cheap valuations.  Historically, management teams have been uninterested in taking steps to unlock value, a process most US companies have undergone in the past 20-30 years.  What has changed is that there are numerous domestic and international investors demanding changes in lock step with pressure from the government and the central bank.  There is already evidence of successful domestic and foreign lead activist campaigns leading to companies untangling cross holdings, buying back shares, increasing payout ratios, and cutting unprofitable business lines.

(Sources: https://asia.nikkei.com/Economy/Japan-Inc-learning-to-live-with-activist-shareholders (Nikkei Asian Review, Japan Inc learning to live with activist shareholders, December 25, 2017);

https://hbr.org/2017/09/japan-is-counting-on-shareholder-activism-to-improve-its-economy (Harvard Business Review, Japan Is Counting on Shareholder Activism to Improve Its Economy, September 20, 2017); https://www.theglobeandmail.com/globe-investor/smaller-is-better-for-these-japanese-hedge-funds/article35932001/ (The Globe and Mail, Smaller is better for these Japanese hedge funds”, August 9, 2017);

https://www.wsj.com/articles/a-successful-strategy-for-activist-investors-in-japan-ask-dont-tell-11555506003 (Wall Street Journal, A Successful Strategy for Activist Investors in Japan: Ask, Don’t Tell, April 17, 2019)). 

This leads us to landscape littered with companies trading at single digit multiples and massive discounts to tangible book with unlevered asset rich balance sheets that could potentially see value unlocked over the next 3-5 years. One company that I believe is the epitome of this potential opportunity is Showa Paxxs (“Showa”). 

At around Y1,500/share, as of 6/14, with 4.4m shares outstanding, as of 6/14/2019, it trades for ~Y6,600m market cap. Trailing earnings as of 3/31/19 are Y1,154m and TBV is Y15,577m, for an approximate PE of 6 and P/TBV of 45%.

In addition, one doesn’t have to scratch too deep to see Y5,360m of net cash, Y4,543m of investment securities, and Y2,000m of real estate, adding up to 11,903m of non-core liquid assets. Put a 5x EBIT multiple on the core business and its worth Y6,860m. This puts the total estimated value at Y18,763m putting the market cap at roughly 35% of a valuation with undemanding assumptions. Assuming a zero cost basis and 30% capital gains tax on the investment securities and real estate lowers the value to Y16,800m, still about 39% of fair value.

What do they do?

Showa makes heavy duty bags. These are for powders and liquids targeted at a range industrial chemicals, food, and plastics. Most of the products are single use and a fraction of the cost of the product it holds. For a solid, the main thing is that it can be lifted and transported without breaking since there could be over a ton of product inside.  For liquids, the same applies. The liquid containers make for easy cleaning. They sell a “system” which is really just a big bladder that is the size of a 20 ft shipping container. Customers can use a common truck to transport their products without the need for a tanker truck or cleaning up. The website has pictures of the products and may prove useful for visualizing the value of the product, particularly the liquids (http://www.showa-paxxs.co.jp/top/products/p02/p02-03/; http://www.showa-paxxs.co.jp/top/products/p02/p02-04/). This is 65% of revenue and 70% of EBIT.

The product is integrated into a supply chain explicitly through the use of the system and somewhat implicitly by the quantities customers order in and the trucks the product is delivered in.  It doesn’t appear to be the type of product one can effortlessly order from a cheap Chinese supplier. The business has been consistent and slowly growing for many years. This isn’t Gilette, but it’s a straightforward product that in my view doesn’t appear at risk of displacement or subject to threats to its existing economics.

The rest of the business is packaging related adjacencies. They sell some plastic film products used in packaging and agriculture, plastic barrels, and packaging equipment. These are less attractive than the core bag business, which earns a high single digit EBIT margin.  Film Products and Packaging Equipment (Others segment) have mid-single digit EBIT margins. The plastic barrels (Container segment) hovers around break even with the occasional minor loss. They also lease part of the HQ which is good for 10% of EBIT, which I back out when discussing the business.

Earnings Power

I can understand the preference to own a compounder rather than be a literal bag holder, but the core business earns Y1,372m of rental income adjusted EBIT on Y7,233m of net assets (Y7,248 A/R, Y2,264 inventory, Y3,298 real estate adjusted PP&E, and Y5,577 A/P) for an 18% pretax return on net assets. Did pre-GFC EBIT margins move from the 2-3% range to 4-5% from 2011-2016 and now 6-7% from 2017-2019?  Sure. A 15% drop in revenue (Y22,000m to Y18,500m) with 4% EBIT margins (Y740m) would get to a 10% pretax RONA.

Capex is lumpy, but a 6-year average going back to FY14 when it was last a big number shows Y570m of average capex, which is 2-3% of revenue. So this isn’t a capex hog and they are earning a decent return on capital they have invested in the business.

Their FY2020 consolidated forecast is 22,000m of revenue, 1,500m of EBIT, and 1,120m of net income (NI does include ~Y100m of dividend income).

Balance Sheet

As of 3/31/19, Showa has 7,023m of cash and 4,532m of long term investment securities.

Real Estate – they own their HQ in Shinjuku, a central Tokyo neighborhood. The building is a 5 minute walk from the Ichigaya train station, which has 5 different subway lines, sits adjacent to a park, and is down the street from the Ministry of Defense. It doesn’t seem a stretch to believe it could be liquid and valuable, particularly in the context of a Y7,200m market cap. The company leases part of it and occupies the rest. The Head Office is on the balance sheet for Y970m, and the rental real estate is carried at Y782m, which if I understand correctly implies they lease out 80% of the building. The FY18 Securities Report gives a market value of Y2,005m, which is 30% of the market cap.  Based on the Real Estate Leasing segment operating profit of Y150m, that is 7.4% EBIT yield.  D&A for the segment was Y53m, so an EBITDA yield of 10%, so the valuation appears sober.

Here is the building and its location.

Investment Securities – The Company has Y4,543m of investment securities as of 3/31/19. This is slightly less than the “Long Term Investments” line item one might see on CapIQ, as that also includes the pension plan assets, which is fully funded. The top 10 comprise 75% of the value and it’s across a variety of Japanese chemical companies, the main customers of the business. 

Here are the top 10 holdings with June 14, 2019 prices.

Interestingly, Showa Paxxs owns 11.3% of Sun A Kaken (4234) worth Y594m. Sun A Kaken trades for ~Y500 and has 11m shares outstanding for a market cap of Y5,400m.  Sun A Kaken (“Sun”) owns ~19% of Showa.  Sun’s stake in Showa is worth approximately ~Y1,250m. Sun trades for under 30% of TBV. Sun has 900m in net cash and investment securities of 4,882m. It is less attractive than Showa given it has been less consistently profitable. If Showa trades for Y18,000m, Sun’s stake is worth Y3,420m and would further drive down Sun’s P/TBV.  [2]

One could also say 10% of 20% is a 2% reduction in economic shares outstanding. It is not inconceivable that if Showa announces a share repurchase, they could buy Sun’s 19% stake. At a minimum, this may be a further source of value that isn’t reflected in my totaling up of the non-core assets on Showa’s balance sheet.

Data Sources

Sources are translated through Google Translate:

[1] Unless otherwise noted, all Showa Paxxs statistical and financial data throughout this write-up is from Showa Paxxs Company Filings, through 3/31/19

[2] All Sun data is from Sun A Kaken Company Filings, through 3/31/19

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 not 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.

The author or his or her respective employer or employer’s clients, affiliates, officers, managers and directors, may or may not hold positions in the Security noted in this article. These parties may trade at any time, without notification to this community, and will not disclose this information to this community. The author and his employer disclaims any liability for investment losses that you may incur under any circumstances.

The author does not hold a position with the issuer of the Security such as employment, directorship, or consultancy.

Catalyst

Catalyst

The absolute cheapness of the company is actually rather new and not a function of hoarding assets for the past 20 years and treading water. In 2014, the company only had net cash of Y108m compared to Y5,360m today, so it has not always been cash heavy. The low capex demands and above average RONA profile mean that this business could get cheaper over time. Tangible book value increased from Y8,345m in FY2010 to Y15,577m in FY19, a 7% CAGR, which is usually not the typical growth profile of a company trading at 45% of TBV. Including the Y1,060m of dividends, the CAGR is 8% (TBV+Dividends). 

It is possible the company unlocks value itself as part of the broader trend in Japan or that it ultimately attracts an activist. The company isn’t exactly hiding assets, such as the value of the HQ, from investors given that they offer a market valuation in their financials. 

Simplex, an activist, owns 2,200 shares, which is pithy in absolute terms and relative to its AUM. They have stakes in numerous companies that have subsequently announced buybacks and higher payout ratios and are mentioned in some of the articles linked to in the beginning. At a minimum, it indicates someone there is potentially aware of the company’s valuation disparity. 

More broadly, it doesn’t take much to become aware of a company like Showa as it screens at a low multiple of both earnings and tangible book, so it isn’t inconceivable to imagine one of the many activists in Japan starts knocking on the door. Strategic Capital, Sparx, RMB Capital, Effissimo, and Lone Alpha are some of the more prominent Japanese-run activist firms.  There are even individuals who are activists like the Murakami family and Beji Sasaki (https://www.bloomberg.com/news/articles/2017-04-24/a-self-made-rebel-takes-on-13-billion-japan-giant-in-m-a-fight) who are taking activist positions in companies.  This isn’t to say any of the above will be interested in Showa, but there is enough activity in the space that could serve as a catalyst for some action.