Thinking Points
- Rinnai (TYO: 5947) leads the Japanese water heater market with a 40% market share.
- However, Rinnai’s Japan share is not the story. Growth outside of Japan has rapidly gained traction over the past few years – particularly in China and the US.
- As infrastructure in ASEAN countries develop, we can expect Rinnai’s ASEAN revenues to grow as well.
If you have experience in residential construction, perhaps you’ve heard of Rinnai before. Rinnai is one of the world’s largest gas appliance manufacturers in the world. The company’s biggest strength is in tankless water heaters (~57% of 2017/3 revenues), which is followed by an almost equally strong gas stove offering (~27% of 2017/3 revenues).
Tankless or not?
Folks in the US are probably not too familiar with tankless water heaters, as most US households (~95%) have storage water heaters. The Spark Notes explanation of the difference is that tankless water heaters create hot water instantaneously while storage water heaters keep a tank of water hot and ready. From an energy efficiency standpoint, the tankless water heater is a clear winner. However, installation of tankless heaters tend to cost more than storage water heaters. Unlike the US, Japan is severely land deprived. Most households don’t have the space for a storage water heater. Hence, tankless water heaters are the norm. For a more comprehensive explanation, read this.
Source: Amazon
The US market isn’t the focal point here, but the US is moving toward tankless water heaters. The Rinnai brand is steadily gaining recognition. In fact, Rinnai achieved the top spot in quality rankings in the 2016 & 2017 Builder Brand Use Study Results for water heaters.
Challenges + the China approach
I was lucky to find a CEO interview on Reform Online (in Japanese), which is a true treasure. Some of the real challenges that Rinnai faces is entirely unrelated to competitive threats. Instead, it’s often a hybrid of infrastructure and culture, especially in Southeast Asia. For example, many countries in SE Asia don’t have the gas infrastructure to reach individual homes. Often times, households have propane tanks, which is adequate for operating a stove. However, a tankless water heater would eat through that in no time. Additionally, water heaters are generally unnecessary, thanks to the warm climate. So far, Rinnai doesn’t have an answer for this problem. Thus, they are limited to selling gas stoves. That said, infrastructure tends to develop as a nation’s output grows, and I don’t think I need to remind anybody about the growth in SE Asia. With time, Rinnai should have a larger presence.
What I found most interesting in the interview is the company’s China strategy. According to Rinnai CEO Hiroyasu Naito, there are 6 major gas companies in China. Rinnai’s strategy is to create partnerships with the gas companies to sell Rinnai products. For example, one Rinnai subsidiary is a joint venture between Rinnai and Shanghai Gas – Shanghai Rinnai Co – which is 50% owned by Rinnai, 45% by Shanghai Gas, and 5% by others. Since Shanghai Gas does not manufacture any gas equipment and Rinnai does not provide gas, there is very little conflict of interest between the two companies.
My general observation is that infrastructure development tends to happen with a bit of delay compared to a country’s growth. After years of continued growth in China, gas infrastructure is still under development. This is finally starting to materialize in Rinnai’s financials. Rinnai’s China sales have grown at a 22% CAGR over the past 5 years. I haven’t looked deep enough to figure out how much growth is left there (or if that’s even something that can be figured out with available info), but I think we have enough information to say that China will have more gas lines in the next couple years than they have today.
The other layer is ASEAN development. I can say first hand that propane tanks are the norm in the Philippines. I have a stove that connects to a propane tank (and no water heater!). Even in the higher end neighborhoods (e.g. gated, armed guard exclusive subdivisions) don’t typically have gas lines – at least I haven’t heard of any in the city I live in (Bacolod). That said, the Philippines, along with all other ASEAN countries, are growing rapidly. Presumably, as ASEAN output increases, infrastructure will develop with a time-delay. Rinnai already operates subsidiaries in many of the ASEAN countries.
Financials (no valuation!)
The big concern for many Japanese companies is the population decline. Less people means less water heater demand. Naturally, investors want to know how much business Japanese companies do outside of Japan. Though Rinnai still generates more than half of its revenues domestically, its international exposure is steadily increasing:
Source: Rinnai Earnings Presentations
An already developed US and currently developing China has accounted for a healthy amount of growth over the past 5 years or so, as you can see in the chart above. The runway for growth in the US is compelling as well, with a tankless water heaters increasing in popularity.
The past 10 years of Rinnai’s performance has been characterized by growing revenues, improving gross margins, and consistent free cash flow. Though revenues dropped in 2009 & 2010, gross margins actually improved and operating income increased. In figuring out Rinnai, it’ll be important to think through how much of sales comes from replacement demand vs. new build demand. This is particularly true for a US market where storage water heaters are increasingly being replaced by tankless water heaters, which generally have a longer lifespan.
Here are a few metrics to give you an idea of what the company is trading for right now:
As a reference, Rinnai has mostly traded around 10x EV/EBIT over the past 10 years.
