Proto Corporation selloff – as overcooked as octopus balls?

Proto is one of two elephant players in its field – Japanese second-hand car sales. The company has impressive net margins (considering that it is in Japan) of 8 -14%, has a very wide moat, has a return on equity of 15.4% (despite lots of cash), yields over 3%, and trades with an enterprise value of around three times operating cash flow. So why the massive sell-off in the last few days?

They missed quarterly results, revised down guidance, reduced the dividend and announced that they are going to spend lots of money on expansion. Basically, sales grew less than expected and gross costs rose more than expected, and the guidance has been revised down because they are doing a lot of expansion. The major issue was the rise in SG&A and Cost of Goods Sold, as can be seen from this diagram (pink = op. inc., green = SG&A, blue = COGS). The good news is that they are putting their balance sheet cash to work (such as by buying a business in Malaysia).

Proto Operating Income miss

Source: http://www.irtimes.com/data/4298/pdf/movie_429813604.pdf

The company has not given a good explanation for why COGS has gone up, other than to say it went up in connection with all of its businesses. The dividend reduction was, frankly speaking, ridiculous. They are swimming in cash and there was no need for it. In my opinion, Japanese companies to do this as a way to demonstrate that they are putting on a hair shirts. However, the reason why SG&A has gone up is because the company is expanding in new areas (medical services, nursing etc.) within Japan, as well as geographically (in Southeast Asia).

The company’s business model

Proto net margin and sales

Most of the company’s income comes from the used car magazine “Goo”, with revenue generated from second-hand car dealer advertisements in the magazine and on their website, car repair information sales, intermediating car exports from Japan, and other car related information. They also make a tiny amount of money from “lifestyle-related” business (medical services and nursing and real estate). Its main competitor is Car Sensor (カーセンサー, http://www.carsensor.net/).

Green = retail; Blue = wholesale prices

Although wholesale car prices in Japan have not been doing very well, the company has been doing a good job of differentiating itself through new services, particularly its certification program, which captures the value in the “market for lemons”. The company reckons that the bottom in used car registrations has been hit (after adjusting for the market distortion of the earthquake).

Pink = used car registrations; Blue = new car sales

Catchy advertising

Here is a catchy advertisement the company runs on TV:

And here is another one:

This ad features a popular “aidoru” (idol) who is a member of a group of forty singing girls targeted at geeks (I’m not kidding). I can assure you that if you listen to this more than two times in one television setting you will not be able to get this tune out of your head for quite a while.

The lyrics are:

Are you on it?

Yes, I’m on it.

If you’re thinking of a car, then it’s Goo-oo

Data in English

You can find a fact sheet with English and nine years of data here: http://www.proto-g.co.jp/IR/library/pdf/fact_20120514.pdf

And they even have an annual report in English:

http://www.proto-g.co.jp/IR/library/pdf/annual_20110819e.pdf

Balance sheet

14.7 billion yen of current assets (10.6 billion of which is cash and 3 billion is receivables) and 5.9 billion of total liabilities. It should also be noted that they have a massive share of mind in Japan, and that intangible asset is worth something, even to a cheapskate like myself

Valuation

Proto valuation

So what we have here is a 23 billion yen market cap company with a mkt cap + total liabilities – current assets of 14 billion, and which is forecast to make 2.9 billion after spending lots of money on expansion, plus you get a strong intangible asset thrown in. Admittedly, the industry background is bad, but the company has managed to grow against a backdrop of seriously declining Japanese car sales and is coming up with new ways to differentiate itself – and, who ever made money by investing when times are good? I do not like the fact that the free cash flow was basically zero last year, but we have to take into consideration that it is better for a company to spend its cash on growth, rather than just keep it under the mattress. If you are worried about free cash flow, consider that despite investing cash flow last year of -1.6 B yen, only 0.5 B yen of that was in capital investment (excluding buying businesses). Clearly, this is not a highly capital intensive business to just keep it running, and they do not need massive amounts of capital for growth even when swimming against the tide of highly difficult business conditions within Japan.