Thinking Points
- Shinetsu Chemicals has healthy exposure to various industries and is an industry-leader in many areas.
- The diversified nature of Shinetsu’s operating businesses helped weather through the 2008/2009 financial mess, though profitability briefly declined.
- Despite a high cash position (net cash at 10% of market cap), Shinetsu delivered respectable low teen ROIC over the past couple of years.
Healthy exposure to various industries
Shinetsu Chemicals is a global leader in Silicon wafers with a 27% market share in 2015. The company is neck-and-neck with SUMCO (TYO: 3436), another Japanese Silicon wafer manufacturer with 26% market share in silicon wafers. That said, silicon wafers is not the only thing Shinetsu is engaged in. In fact, the company maintains a well diversified, balanced diet of 5 different business segments:
Source: Shinetsu IR
Certainly not the most aesthetically pleasing pie chart I’ve ever seen, but you get the point: Shinetsu has its hand in different areas.
Frankly, the diversified business exposure has worked well for Shinetsu. When one segment does not perform well, usually the other segments keep the company chugging along. The main risk in building a diversified business is being a jack of all trades and a master of none. However, Shinetsu appears to be a master in everything they do.
Source: 2016 Annual Report (English)
Don’t worry, I don’t know what most of this stuff is either. In fact, I principally do not invest in chemical companies, or even research them for the most part. That said, I don’t think Shinetsu requires too much reading to figure out that it is a well-oiled machine. For the non scientists that are reading this who are interested in knowing what the stuff above actually is: The annual report provides high level explanations on some of the material applications.
Delivering stable, respectable business performance with high cash position
Initially, Shinetsu came on my radar because of their high cash position. Net cash per share is about 965 yen, which is roughly 10% of today’s appx. 9,500 yen share price. This is significant, considering the company’s $37 Billion market cap.
Now, a problem that’s plagued many Japanese companies in recent history is huge cash positions dragging ROE/ROIC performance. Often times, the high cash position is held with a doomsday scenario in mind. Another problem spotted regularly is cash rich Japanese companies that come with questionable operating businesses. Shinetsu does not fall into either of the two categories. Even with the large cash position, Shinetsu has delivered low teen ROIC over the past couple of years. Adjusted for cash, ROIC would fall somewhere around high teens to low 20s.
I tend to think that business performance during the 2008/2009 global financial mess is a pretty good indicator as to how well a company is built. In Shinetsu’s case, operating income took a steep dive in the 2010/3 reporting period (~50% YoY decline). However, the company still delivered a relatively healthy ~7% ROIC. In comparison, SUMCO reported operating losses during 2010/1 & 2011/1.
Financials & Closing
There is very little to dislike about Shinetsu Chemical. If I really have to nitpick, I would prefer to see positive free cash flow in the 2008/3 reporting period. Having a small amount of debt with the enormous cash position seems odd too. Otherwise, the financials are spotless. Healthy balance sheet, operating business, and cash flow situation.
Tearsheet
There’s a lot to like about Shinetsu, like its market leading position in various areas and stable business performance. For investors familiar with chemical companies, Shinetsu is worth a look. For those not too familiar (myself included), it’s at least watchlist worthy. My principle valuation metric is EV/EBIT. Perhaps my view is distorted from the smaller cap Japanese stocks I look at, which often trade at low single digit (and sometimes even negative) EV/EBIT. I’d be a little hesitant at 13x.
