Thinking Points

  • Nissin Tools (TSE: 6157) is one niche Japanese company the world cannot live without.
  • Specializing in precision end mills, Nissin Tools has the capability to cut letters onto a human hair.
  • As the Internet-of-Things movement continues, there will be more applications for Nissin’s world-class precision end mills.

Overview

I wish I had known about Nissin Tools sooner. Way sooner. With a 46.7 billion yen ($426 million USD @ 1 yen = 0.0091 USD) market cap, Nissin is deep in the small cap territory. That said, the company delivers business performance comparable to some of Japan’s top industrial companies, like Fanuc (TSE: 6954) or Nabtesco (TSE: 6268):

Source: GuruFocus

That sort of business performance is hard to ignore, especially coming from a relatively small company. Nissin’s leading business performance combined with its recent move from section 2 to section 1 listing (September 2017) on the Tokyo Exchange seems to have caught the attention of many investors:

Source: Google Finance

At a 15.9 EV/EBIT multiple, however, it is difficult to say whether Nissin Tools is currently actionable. That said, Nissin Tools is a high quality company that would be nice to know about when times are difficult and valuations are depressed. The company can’t change the cyclical nature of manufacturing, after all.

What is an end mill?

First, it would probably help to understand what an end mill is. Frankly, I didn’t know exactly what the difference between an end mill and a drill bit was until I read about Nissin. Here is Wikipedia’s description:

“An end mill is a type of milling cutter, a cutting tool used in industrial milling applications. It is distinguished from the drill bit in its application, geometry, and manufacture. While a drill bit can only cut in the axial direction, a milling bit can generally cut in all directions, though some cannot cut axially.”

Nissin offers various shapes of end mills:

Source: NS Tools

In addition to the various shapes, end mills can be categorized by size and material. In essence, the smaller the size and the harder the material, the higher the technical expertise required to manufacture.

An end mill’s size and its relation to technical expertise is a given, so I’ll talk a little more about the hardness of material. Basically, if the base material of an end mill is harder, it can cut through harder materials (and regular materials faster).

As a simple illustration, let’s say we have a hardness scale of 1 to 5 (with 5 being the hardest). A 5-base material end mill can cut through a 5-level material. A 4-base material cannot cut through a 5-level material, but can cut through a 4-level material. If you use a 5-base material and a 4-base material end mill to cut through the same 4-level material, the 5-base material will cut faster.

According to Endmill.com, the most common end mill base material is High Speed Steel. Cobalt and carbide end mills are also very common. Additionally, CBN (Cubic Boron Nitride) and PCD (polycrystalline diamond) end mills also exist, but are more specific in application. There are also various types of coatings that affect hardness.

PCD is at the top of the hardness scale, followed by CBN, Carbide, Cobalt, and finally High Speed Steel.

Nissin specializes in precision carbide end mills (under 6mm [0.236 in] diameter). The company is also strengthening its precision PCD and CBN product lineup.

End mills, as the name suggests, are used on milling machines. Here is Fanuc’s popular Robodrill Machining Center (Machining center is a catch-all term for CNC milling and drilling machines):

Source: Fanuc

These sort of machines are used to make everything from precision parts to auto parts to home appliance parts. Desirable qualities for a precision end mill include: consistency, durability, and cutting speed.

Why Nissin Tools?

Nissin Tools isn’t the only player in the precision end mill business. In Japan alone, competitors include: OSG (TSE: 6136), Hitachi Tool (subsidiary of Hitachi Metals [TSE: 5486]), and Union Tool (TSE: 6278). These are formidable competitors, especially with OSG’s Toyota Motors (TSE: 7203) affiliation and Hitachi Tool’s Hitachi Group backing.

Fortunately, Nissin Tools is the only company focused specifically on precision carbide end mills. According to Nissin’s fiscal 2017 earnings presentation, Japan’s carbide end mill market was a 49.1 billion yen ($447 million USD) market in 2016. Of the 49.1 billion yen, Nissin estimates that the precision carbide end mill market was about 18 billion yen ($164 million USD). Of Nissin’s 8.8 billion yen ($801 million USD) of fiscal 2017 revenues, about 6.3 billion yen ($570 million USD, 72% of total revenues) came from precision carbide end mills. This gives Nissin about a 35% Japan share in precision carbide end mills.

At this point, it’s clear why big companies have not come in to sweep the market. The various end mill shapes, base materials, and coatings all combine for a 18 billion yen ($164 million USD) per year market. This means end mills are produced in small batches, which means it’s difficult to realize scale benefits. Moreover, much of Nissin’s production process is automated. In fact, the company designs some of its own machines and software for high precision end mill production as general purpose machinery and software doesn’t always meet Nissin’s needs. Hence, large companies have a difficult time not only establishing a product line, but justifying an entrance into an 18 billion yen ($164 million USD) market with high technical barriers.

Growth going forward

In a Nikkei radio interview from December 2017, Nissin Tool CEO Hiroji Goto talked about a couple of the various applications for Nissin’s precision end mills. One example he mentioned was the camera lens for smartphones. According to Hiroji, there are usually 4 different camera lenses inside a smartphone that work together to capture an image. Each year, more functionality is added to the modern smartphone while the size of the smartphone remains roughly the same. This means parts for each functionality must get smaller in order to fit. With camera quality being a key selling point for many smartphones, the 4 camera lenses need to be positioned properly to capture high quality images. Nissin’s precision end mills are often used to create the module that keeps the 4 lenses in place. There are other companies that offer end mills for similar parts, but when companies want a greater degree of precision or more consistency, Nissin’s end mills are used.

The Internet-of-Things (IoT) movement brings similar opportunities for Nissin Tools as well. In connecting all sorts of devices to the internet, the demand for sensors are on the rise. This is where Nissin’s precision end mills exert its strength. In addition to the general IoT movement, Hiroji is excited about self-driving cars as well, calling it “a bundle of sensors”.

Some may be surprised to find that every Nissin Tool product comes out of one factory in Sendai (Northeast Japan). Nissin has no interest in moving production outside of Japan. In fact, Hiroji sees the focused nature of the company as a selling point. This comes with risk, of course, like when the Tohoku Earthquake struck northeastern Japan in March of 2011. No employees were hurt and structural damage was minimal. However, Nissin’s Sendai plant was shut down for 3 weeks, primarily because some of its machinery was out of position. With precision manufacturing, positioning matters.

Despite the heartaches, Nissin remains focused on concentrating its resources in the Sendai plant. Instead of opening another plant in another location, the company carries 3 months of inventory as a buffer.

The bottom line

Regardless of current valuation, Nissin Tools ought to be on every investor’s watchlist because of its unique competitive position in a highly niche precision end mill market. The balance sheet is clean with a 0.85 equity-to-asset ratio and no debt. The company’s world-class precision and highly automated small lot production process keeps Nissin Tools competitive both from a technical and cost standpoint.


Kenkyo Investing
Kenkyo Investing

Kenkyo Investing applies a value investing approach to Japanese equities, providing insights that are often unavailable to non-Japanese speakers.