Mitani Shoji – Tough octopus to kill, hated by market, dirt cheap

by admin on July 2, 2012

This post is about Mitani Shoji, a net-net Japanese stock.

Mitani Shoji (aka Mitani Corp, 三谷商事, 8066) is a trading company. It gets involved in a lot of stuff, like many trading companies, and has three very roughly-cut business segments.

This company has grown assets per share from 1,794 yen in 2008 to 2,430 yen recently (CAGR = c. 7.9%), which is good for a very cheap stock. It is the market leader in construction gondolas and is a big player in cement (20% of sales).  In my opinion the management’s constant complaining about weak demand, a negative earnings forecast, huge concentration of influence with the Mitani family, unfathomable sprawl of businesses, spending money on real estate and wind power projects on which there is little known, recent bad press about a fair trading violation with its Fukui gasoline stations (and potential need to withdraw from that business) and confusing strategy are behind the market’s dislike of it.

This is an addition to the great write-up by Adam on Value Uncovered. I just looked into this company and wrote some notes for myself. This is a write-up out of my notes. I am not going to repeat what Adam already wrote, just add my own notes from reading the Japanese releases. Also note that I did not look at the English data, but there usually is more available in Japanese than in English.

Segments:

 IT:

Sells IT equipment, software, provides maintenance services, as well as image processing services and many other things.

Management commentary from most recent quarter:

IT business being driven by pick-up in IT investment and increase in sales of equipment to local governments.

Business Supply:

Consists of cement, raw concrete, other bulk building materials oil refined products, building materials, construction gondolas (“gondora” in Japanese), building leasing, various chemical products, glasses for old people, wind power, and semiconductor wholesale, and 20 other subsidiaries.

Management commentary from most recent quarter:

Oil refined product sales up due to increase in sales prices, building materials sales volumes up. However, op inc is tough in building materials, and semiconductor op inc falling.

Lifestyle/ Local Services:

Cable TV, internet, old people’s homes, car sales, fuel retail, raw concrete, LPG, housing repairs, and restaurants, and 105 other subsidiaries.

Management commentary from most recent quarter:

Op inc big increase. Building materials competition “continues to be very intense”, but energy products were responsible for increase in sales. Op inc was improved by getting rid of some loss making subsidiaries, and by contribution from old peoples’ homes

 

Strategy

Aim is to be the “top company in each of their businesses and geographical areas” in the IT and Lifestyle business segments.

Forecast is pretty gloomy. Saying that the one-off demand hit in the gondora business is declining and that bad debts are expected to increase.

 

Just for reference, I went and looked at the 2011 annual outlook. If anything, it was more pessimistic than the recently released outlook, in-line with Adam’s analysis, and indicating that not too much weight should be placed on what the management say.  Also, I noticed on the weekend there was a story in the Nikkei Shimbun about a 20% increase in concrete production.

Change in business segment margins:

It is worth looking at segment performance over time – IT has the best margins:

Mitani op inc by segment Mitani op inc by segment

But Business Supplies provides most of the op inc.:

Mitani segments Mitani segments

Cashflow

They are investing in income property (cap rates in Japan are about 5%), and they are spending money on the second phase of a wind power generation project. Investment cash flow spent on fixed assets in the 12 months to Mar 31, 2012 was 7.3 B yen vs. net inc of 6.4 B yen and 3.5 B yen of DD&A, which means that FCF is only 2.6 B Yen (NB: I do not remove dividends of 0.53 B yen from this because it is a direct return to the owner).  You could argue that this capex is for expansion, so it is not recurring and should not be part of your overall picture of the business. However, I think that you should factor in this kind of capital spending into the long-term picture, because given the company’s strategy it is not likely to go away soon. Once they build the wind farm they will find an expensive acquisition in SE Asia or something. Also, I am not sure what kind of return to assume for the invested capital, but it would be conservative to guess that they are very low.  Considering that REITs such as Hankyu (owns all the best parts of Osaka) are trading steep discounts to NAV, you have to assume that the market is not happy with them putting new money into real estate (at undiscounted prices).

Increasing dividends

Increased final dividend from 10 to 11 yen – great. That means that full year payout is 22 y/sh (2.3% – so so). Have a lot of room to increase the pay-out, but not so much if they want to move in all four cash utilization directions at the same time (increase financial strength, spend on domestic growth, spend on overseas growth, and increase divs).

Forecast:

It is important to note that while the top line is forecast to grow, the bottom line is forecast to shrink this year (from 6403 M Yen to 5800 M Yen, -9.4%). http://www.mitani-corp.co.jp/ir/2012050901.pdf

EPS for Y/E Mar 2012 is 210.61, which is a 4.6% CAGR from 2008.

Ownership:

Biggest owners are themselves (11.91%), a certain Mitani foundation (7.11%), another company also called Mitani (7.01%), and yet another company also called Mitani (5.79%).

Connections

Probably the best way to get a quick check of whether such a company is politically connected (and all trading companies have to be, to some degree at least, politically connected in order to survive), is to check their long-term investments. In the Japanese financials, long-term investments (or “held to maturity”) are amusingly referred to as  “investments held for reasons other than for making a profit”, and there are reasons given such as “in order to strengthen transactions and relationship”.

In the case of Mitani, the two largest “non-financial” investments are Hoku Hoku Financial Group (ほくほくフィナンシャルグループ, 8377, 451 B Yen of net assets) and Hokkoku Bank (北國銀行, 8363, 209 B Yen of net assets). Taking a view on the creditworthiness of any Japanese trading company involves taking a view on the solvency of its banks. Hokkoku has a Tier 1 ratio of over 12%, Hoku Hoku is at about 7.5%.)

Strategy

The company mentions several times that they are bearish on Japanese internal demand and that they are looking for global growth. This is not surprising, but they do mention it so much that the impression you get is that they are desperate to do an expensive overseas takeover (expensive).

Great little line “We do not have much debt, but we want to be a good company.” They go on to say “We are financially stronger than before, but we want to be a good strong company which can even withstand this era of volatility”.

So that basically contradicts the statement about wanting to spend lots of money overseas. Not completely abnormal given the fuzzy thinking at many Japanese companies, and the fuzziness of the Japanese language in general.

They are planning to invest in the “silver business”, which is a Japanese expression for “grey-hair demand”. Although this is not a major part of their business, one should note that there is an important new trend in old people’s homes which is a serious threat to the companies lining up to invest in that area. The government is prioritizing reimbursement for stay-at-home nursing. The majority of costs of old people’s homes are in the building and they will be at a competitive disadvantage to call-out nursing at home services, which are taking market share. More on this in another post.

Mid-to-long term outlook:

IT: Moving into high margin areas such as services and software

Business supply: Demand falling, competition intense, but they are trying to do something about it

Lifestyle: Inane comment about keeping users happy

New growth: Getting into old people’s homes and growth in emerging markets. Nice one guys – welcome to the party, only that you’re ten years late.

Balance sheet

Here are the major items that might go into a bankruptcy-value based valuation:

Mitani balance sheet Mitani balance sheet

The one thing that automatically jumps out at me is the huge proportion of these assets that is made up by receivables.

Therefore, the first thing I looked at is counterparty risk.

Counterparty risk

It turns out that they do not have any real concentration of counterparty risk. The largest accounts receivable counterparty is another Mitani company (again), at 1.6 B Yen out of 48 B Yen, and its largest bill debtor is another trading company at 0.87 B Yen out of 15.5 B Yen. However, out of the listed counterparties, most appear to be involved in construction, so that is a systemic exposure to be aware of.

Pensions:

The company has a defined benefit plan, a lump-sum retirement plan and a defined-contribution plan. Their estimated obligations are only 3.6 B Yen, and are largely covered by pension assets (2.9 B Yen, before actuarial revision).

Products and semi-finished products:

These are most IT-related, so I wrote them down to zero.

Shares in related companies: 9.7 B Yen. How much to write this down by? Basically, these shares will never be sold, so what value do they provide? Cut by40%.

Valuation

The company is a net-net at present, and its diversification-gone-mad (only 20% of sales from cement according to Reuters) is surely a buffer to prevent it from any systemic impact from any serious decline in anyone of its many, many subsidiaries.

However, due to the large proportion of its valuation represented by receivables, a 20% haircut to that figure brings the bankruptcy value down significantly. Note that reducing the discount for receivables to 7% would equalize the current market cap with the stress-case bankruptcy value (assuming all the other discounts stay in place).

Further, you need to give it something for its free cash flow, but since its free cash flow is about 2.6 B Yen and not expected to grow much, at least in the near future, you would not put a high multiple on it (5? 6?). That admittedly still does improve the valuation significantly, but does it make the company a screaming buy?

This company may be attractive to some as a play on domestic demand, and, importantly, its track record of NAV/sh growth is not bad, given the severe domestic economy over the past few years. Its widely-spread tentacles make it a tough octopus to kill (if you have ever had really fresh octopus, you know what I’m talking about). In the short-term there could easily be a pop in this name as pessimism over the sky falling in due to China may (possibly temporarily) give way to a focus on domestic demand drivers. However, due to the inherent unfathomability of its myriad subsidiaries, and its domination by a single family, it is difficult for me to have strong conviction on this name, despite the cheapness and apparent safety. Investing in a conglomerate requires, for me at least, either a large dose of trust in the management, or a potential catalyst in the form of something like a new strategy. Mitani  is the poster-child of Japanese insider boys’ club management, and its wooly strategy and flimsy disclosure make it difficult to have real conviction for me.

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