Surprising stability at construction widget maker – net-net analysis

This post is about Daiken, a net-net stock.

Daiken (ダイケン, 5900; not to be confused with Daiken Medical) makes and sells things made out of metal used in construction. This stock was mentioned on Oddball Stocks, an excellent blog.

You can see their catalogue here: http://www.daiken.ne.jp/catalog/pdf/p05_5_2.pdf, but to me essentially it makes widgets. It has two segments: Construction Related Products, and Real Estate Leasing, although the latter is negligible. They talk about added-value products, but I do not know how much value you can add to a metal car park roof.

The demand for their products basically depends on construction activity within Japan. This had a temporary boost following the earthquake last year, and the company says that there are parts of the economy in which there is strong capital investment. The company focuses on providing metal construction products for dense housing in urban areas. Those who immediately point to a declining birthrate and say that this is a dying industry should note that major cities in Japan, and particularly Tokyo, are still growing, albeit at the expense of the countryside. Further, in recent years there has been a trend for growth in single person households, which arguably may increase demand for housing despite a falling population. Separately, everything in Japan is constantly being rebuilt, and whether due to earthquakes (tiny tremors every day mess up structures pretty quickly), whether it is just to stimulate the economy, or by habit, it is part of the way things are done, so there will be continued demand for various outdoor metal structures. Having said that, this is a very mature market, and it would be unreasonable to expect the company to break out of its 1.9 – 2.5% net income margin band of recent years any time soon.

So this is somewhat of interesting company due to its “pure widget” nature – perhaps a pure Graham play?

Ok, let’s get right into it and look at the balance sheet:

Daiken balance sheet

Interestingly, the first thing that jumps out at me is that the biggest single contributor to their value is their receivables position (note that I combined the accounts receivable and notes receivable line items here). They actually have 2.0 billion of bills and 1.96 billion of accounts receivable.

The top two counterparties are:

Bills:

杉田エース株式会社 (Sugita, 7635): 668 M yen

In the same business as Daiken, 16.7 B yen of current assets, of which 12 B yen is receivables, 15.4 B yen of liabilities

株式会社クマモト: 217 M yen

Not listed

 

Accounts receivable:

杉田エース株式会社 (Sugita, 7635): 464.8 M yen

Same as above

ユアサ商事株式会社 (8074): 135.4 M yen

Current assets of 160 M yen, of which 108 M yen is receivables, 162 M yen of total liabilities. Receivables spread out of many counterparties.

 

So the total receivables concentration with one company (Sugita) is over one billion yen – fairly significant.

Sugita’s sales look like this (2008 – 2012):

Sugita sales

Basically, this concentration is a potential problem, so I will take a 30% cut to receivables owed by Sugita and 15% for the others.

Securities

Although they have around 1 billion yen in investments, only one third of this is in securities, and about half is in insurance deposits. I have no idea how much of the insurance deposits might be worth, so I will value them at 25c on the dollar, and value the rest of the investments at a 20% discount. Also, it is not meaningful for the valuation, but I was pleased to see that they are up on their marketable securities (all of which are shares) by 15% from the point of acquisition (they were underwater last year).

Land

They have quite a lot of land. They break out their land in their annual report, but only by area and not by value. If you are interested, you can find the locations of the factories listed in Yahoo Japan, and figure out more or less what that factory land might be worth. In my stress case I assume that it is worth 15c on the dollar. The actual value could deviate hugely from the book value, depending on the time when they bought it and how much they have written it down by. It is worth noting, however that all the factories are in highly built-up areas, such as Yodogawa-ku in Osaka (a stone’s throw from where I used to live – nice place). They have some 280,000 meters squared in that district alone, and 554,000 meters squared in Narita, near Tokyo airport. Remember, that they also have investment real estate, however, the best way to value real estate in my opinion is as a cash-flowing asset, and since it appears to be cash-flowing very little, I do not consider it here. However, if I get more interested in this company, I might geek out on Yahoo Japan Real Estate and try to figure out the worth of this stuff.

I noticed that they increased their credit line with six banks from 2 billion yen last year to 3 billion this year. Could be useful if Sugita runs into trouble.

Finally, I should mention that their cashflow is surprisingly stable for a company in this business. They are currently running at a rate of 370 M yen in net income, 330 M yen in DD&A and an average capex of 214 M yen for the last two years. The intriguing thing is that even though their sales fell from 13.1 B yen in 2008 to 9.5 B yen in 2011 (NB: forecast for sales is 10.5 B yen in 2013, eps is 370), their net income was 353 M yen in 2008 and 299.9 M yen in 2011 – incredible stability for a construction product buisiness in a tumultuous economic period (admittedly, net income dived to about one third of that in 2009, but still it was positive). The only clue as to why this might be is they say they continually reduce costs and optimize logistics from their six factories.

Conclusion

This is quite a Graham stock in that it is a widget maker (in my opinion). However, clearly they have some form of ability to decrease their operational leverage, which is admirable. With the market cap of 2.3 B yen it appears that this stock has been left for dead, as the stress case bankruptcy valuation is significantly higher, at 4.5 B yen, and that gives it very little value for its land, no value for its investment real estate, and a healthy chop to its receivables. On top of that, you get something like 400 M yen in FCF per year and a 12 yen dividend (3% at the time of writing). An interesting play – a stock that apparently is safe, despite a company which, at first sight, it is anything but.