Shares of Sugimoto (TYO:9932) have been creeping up a bit lately. As the stock is now trading much closer to net current asset value (around 0.89x, including the long-term investments), I decided to sell my shares. I figured there had to be something cheaper out there. With my Japanese holdings I’m more inclined to sell something relatively cheap and make a switch to something that looks even cheaper. Since I do not know the companies well due to the language barrier, I try to just look at the numbers and to not become attached to any individual company.
Even in Japan the bargains are slowly but surely disappearing. One of my book value screens for Japan on FT.com is down to 43 companies. One year ago there were at least twice as many companies that fit the criteria. Fortunately there are still a number of net-nets and book value bargains out there, even though they are becoming tougher to find.
To replace Sugimoto, I bought Daiken Co Ltd (TYO:5900).
Daiken (company website) manufactures and sells architectural hardware, exterior building materials and other exterior products. Their products include: various types of window blinds, aluminium eaves, mail boxes, delivery boxes, floor vents, grating, curtain rails, etc.
Financial snapshot:
Stock price: ¥615
Outstanding shares (excl. treasury shares): 5,874,437
Market cap: ¥3.6 billion
NCAV (Nov. 30, 2014): ¥5.8bn
Book value: ¥11.0bn
Cash: ¥3.3bn
Total liabilities: ¥3.1bn
Daiken is trading at 0.62x NCAV and 0.33x book value. The company is not growing. Revenues have been pretty flat since 2010. The company produced earnings of around ¥400 million per year in that period, so it has been a relatively stable performance. The cash flow statements look solid as well. The company is able to translate those earnings to actual cash. Daiken’s cash balance has doubled from ¥1.4bn in 2010 to ¥2.8bn today.
The main things not to like about Daiken are of course on the capital allocation front. The company pays a small dividend of ¥14 (a 2.3% yield) and there have not been any material share repurchases in the last five years.
A few technical factors might also put investors off. The lot size for Daiken is 1000 shares, which means an investor needs to put up almost $5200 USD to take a position in the company. Many small individual investors will not like this. Daiken is also a small cap with a market cap of around $30 million USD. The company will be too small and much too illiquid for most fund managers. So I don’t think the company appeals to anyone: neither to retail investors nor to most professional investors. Finally, the company is listed on Jasdaq in Japan and not on the main exchange. These factors probably provide a reasonable explanation for the incredibly low valuation of the shares today.
I don’t worry about a lack of catalysts, excess cash sitting on a balance sheet or illiquidity. These elements are all present in Daiken. Buying companies like this has worked out well for me in aggregate, even though individual stocks might not do much for years.
Disclosure: long Daiken Co Ltd (TYO:5900)
Stock does not qualify as cheap. Have you taken a look at the off-balance sheet items…
Thanks for the comment. I went through the notes of the annual report with Google Translate and I think there is a large pension deficit. If I’m reading things correctly there is a pension deficit of ¥1.8bn (page 56 of the securities report: http://www.daiken.ne.jp/wp/wp-content/uploads/2014/12/ir_yuuka_pdf_66.pdf). That is obviously a huge off-balance sheet liability given the company’s size. I totally missed this in my first review of the annual report. It makes the company a lot less attractive for sure. Thanks again for pointing this out. I’ll update the post to refer to these comments.
Well, I don’t think it’s quite as bad as that. If I’m reading it correctly, they participated in a pension fund jointly with a group of other companies. That pension fund decided to dissolve in Nov-13, with plan assets about Y1.8bn less than plan liabilities. BUT Daiken’s share of contributions was only 16% of the total pool. Now, as Daiken states, that doesn’t mean they’re responsible for exactly 16% of that deficit (paraphrasing their disclosure — “it’s complicated”), but surely they aren’t responsible for all of it…
Thanks for the clarification. I’ve taken another look and I think you’re right about their share of contributions to the pool. That is reassuring. I’ll try to take a look at some earlier reports to see how the deficit has developed over the last few years.
Hi, thanks so much for these insights. When I look at Japanese companies I have noticed that their “Net defined benefit liability” is usually ON balance sheet. For example KYOWAKOGYOSYO CO., LTD. [5971] (https://www.kaijinet.com/jpExpress/Default.aspx?f=company&cf=financial_statement&cc=5971).
When you identified these off balance sheet pension liabilities are they in relation to a defined benefit scheme or a defined contribution scheme? My understanding is that only a defined “benefit” scheme matters when calculating the NCAV.
Thank you,
G
Hi G-Man,
I believe you mainly have to worry about defined benefit schemes. Those rely on a number of assumptions (like the expected rate of return on plan assets) that could prove to be much too optimistic, increasing the liability for the company.
So for the company you mentioned (5971) the defined benefit liability is on the balance sheet, but this is only a current estimate of the liability. It could prove to be significantly larger or smaller in the future. Given that the liability is only ¥175 million and the company has ¥5000+ million in cash and securities, it doesn’t seem like much of a concern to me, but I’m not an expert.
I don’t remember what the situation was for Daiken. It’s pretty hard to decipher Japanese financial reports. There was a large off balance sheet item, but it seemed unlikely they were on the hook for the full amount, see the discussion above.
I generally invest in Japanese companies with a very solid balance sheet, much like the company you mentioned. For most companies in my basket I don’t think it is much of an issue.
Dear Paul,
The liquidity issue you mention is definitely an issue micro/nano caps face. I was looking at a random stock trading at a volume of a paltry 20,000 shares a day and at a price of 7 cents. There can be weeks where no shares are traded at all. It seems quite difficult for me to enter/exit a position of a few thousand dollars.
I have a few questions on liquidity.
1. How do you purchase these highly-illiquid stocks without moving the share price? I believe if you do roughly 5-10% of the stocks ADV, it is enough to move its price.
2. Do you have a rough figure of volume which you look out for when investing in a stock? For example; 500,000 shares trading daily?
3. What specific volume is considered liquid/illiquid to you?
Thank you.
Hi valueinvestor,
1: Moving the share price can be an issue. I don’t mind moving the price a little and perhaps just pay the ask price when I believe a stock has at least 50% upside. Sometimes you have a choice of either paying up a percent or two and getting the position size you want or not getting the position you want. If a company is deeply undervalued I think it is better to just pay up a little.
I have had one example (French company Gevelot) where I was trying to get in at a 52-week low price and not move the price and where I didn’t get a fill on my order and the price moved away from me. Shares were still very cheap at the higher price, but psychology works against you (anchoring) and it becomes very difficult (for me at least) to buy at a price that is perhaps 20% higher from where you first tried to buy. That company moved up from €40 to €140. It was a huge mistake.
2. I don’t have a requirement for a minimum amount of volume. I’m a small investor and the illiquid positions I have tend to be fairly small positions as well. So volume has not been an issue for me.
3. I don’t have a specific volume in mind when I use the term. I think everyone has a different idea about what is liquid or illiquid. Sometimes I hear large cap investors talk about a stock being illiquid and when I check the volumes, millions of dollars of stock trade hands every day. I think for me to call a stock illiquid means that the stock sometimes does not trade for a few days.
Thank you for your swift reply. Looking forward to your next post!
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Thanks so much for your fast reply. I refer to your response on March 27, 2017 at 11:23 am.
Ultimately, I am trying to understand what the Japanese accounting standards mandate with regard to defined benefit plans. Are they meant to be disclosed on the balance sheet or can they legitimately be tucked away in the notes thereto? Perhaps this question is a bit too esoteric but thus far I have not been digging into the notes to the financial statements on the proviso that defined benefit liabilities were always reported on the balance sheet.
Thanks again for your help, it is much appreciated.
G