Thinking Points

  • Mystar Engineering (TSE: 4695) is a medium quality business with medium prospects primarily engaged in mechatronic and facility maintenance.
  • Though the company comes with pockets of strong positive characteristics (talent development), there are worrisome factors (nepotism).
  • Fair value for Mystar is about 1,300 yen per share (vs. May 29, 2018 790 yen per share) with no clear catalyst. Only patient investors with long term diversified portfolios ought to invest in Mystar. Depending on how long it takes for fair value realization, Mystar may deliver 18.1% (3 years) or 10.5% (5 years) investment CAGR.

Overview

Mystar Engineering (TSE: 4695) is an engineering company with a focus on mechatronic maintenance and facility operation services. More recently, the company started focusing on integrating energy management into its current business lines while incorporating a senior-heavy workforce.

Today, its revenue distribution looks like this:

Source: Company filings

The company makes for a rather unexciting story, which seems common among maintenance service businesses. Its biggest asset is its army of technicians that work diligently to solve its customers’ domain specific problems.

Fortunately, other aspects of Mystar Engineering make the company a rather compelling investment. Other aspects include, stable business performance, history of share buybacks, consistent dividends, and a low EV/EBIT ratio of 1.6 (considerably healthy recent operating performance).

 

Company info

Mystar Engineering got its start in 1969. Its first business focus was on building facility maintenance services. In 1981, the company expanded into testing and conditioning of industrial plants and mechatronic equipment. By 1984, Mystar started offering maintenance services for semiconductor manufacturing related equipment. In 2000, the company leveraged its experience in facilities maintenance to move into facilities management.

The management philosophy of Mystar is based on Confucian principles. More specifically, founder and chairman Shigeo Hirano cites the beginning of one of the “Four Books”, Great Learning, in the management philosophy page on Mystar’s corporate site (Japanese). The essence of Mystar’s management philosophy is the focus on personal identity as a part of the building blocks of the company.

The management philosophy is reflected in its training program, which helps employees build their own future. It flows like this:

Source: Mystar Engineering (Japanese)

Both specialist and generalist focused employees have the opportunity to move into management. Though very basic, the two track approach with the employee as the decision maker is a model that other Japanese companies can learn from.

According to reviews posted on Kaisha-no-Hyoban (Japanese), a Glassdoor-like anonymous company reviews site, Mystar’s two-month initial training program is a generally positive and valuable experience. Overall, however, the company posts a mediocre 59 out of 100 score. It appears many employees are generally satisfied with the company, but would like more recognition and a larger paycheck.

Segment info

Facilities

The facilities segment makes up for 49% of fiscal 2018 consolidated company revenues. This segment covers a wide variety of work, including hotel & shopping center management, general maintenance services, cleaning & security services, facility construction/renovation, engineering & design, etc.

Because the segment covers a wide range of work, it’s difficult to determine what Mystar’s core segment strength is (presumably that it can handle a wide variety of work).

Mechatronics

The mechatronics segment makes up for 34% of fiscal 2018 consolidated revenues. This segment is mainly engaged in the design & engineering, manufacturing, and maintenance of mechatronic equipment, with heavy exposure to the automotive and semiconductor industries.

Content

The content segment accounts for 18% of fiscal 2018 consolidated revenues. The segment is mainly involved in studio management, broadcasting equipment maintenance/support, and event-related production management.

Concerns

One of my key concerns with Mystar Engineering, quite frankly, is nepotism. Daisuke Hirano, the founder and chairman’s son, was appointed as the new CEO in December 2017. Daisuke has an MBA from Columbia Business School and a brief tenure with McKinsey & Co Japan (less than two years), which are both nice resume line items. However, he only started his employment with Mystar in July 2016. While tenure isn’t a good indicator of experience quality, Daisuke’s short tenure, rapid rise through the ranks, and family association likely leaves many tenured employees with doubts.

Another concern is Mystar’s mechatronics segment exposure to the semiconductor and automotive industries. Both industries are cyclical and have performed well for some time. Despite its focus on a generally more stable maintenance operations, the company isn’t immune to cyclical downturns. This can be seen in fiscal 2010, when Mechatronics segment revenues declined 32% year-over-year.

Business performance

Overall, there isn’t a whole lot of qualitative information available on any one of Mystar’s business segments. Though the company comes with pockets of strong positive characteristics (talent development), there are worrisome factors (nepotism).

Aside from the cyclical exposure in the mechatronics segment, the company delivers consistent and stable business performance. Gross margins float between 15 ~ 19% and operating margins (with the clear exception of fiscal 2010) float between 3 ~ 5%. The company generates consistent free cash flow more or less in line with net income.

Though with some fluctuation, revenues have grown at a 1.68% CAGR over the last 10 years while operating income grew at 4.31% CAGR. More importantly, Mystar management pulled the trigger on share buybacks before it was cool, however, this was more due to external circumstances. A previously major shareholder, Itochu (TSE: 8001), expressed interest in selling, so Mystar proceeded with buybacks on a couple different occasions (2013, 2014, & 2016). Regardless, this puts 10 year revenue per share CAGR at a considerably more attractive 3.19% and EBIT CAGR at 6.87%.

For fiscal 2019, Mystar is projecting revenues of 19,000 million yen ($174 million USD, 1.7% increase YoY) and operating income of 780 million yen ($7.2 million USD, 2.2% increase YoY). This makes for a standard 4.1% in operating margin. The best I can say is that Mystar is a medium-quality business with equally medium prospects.

Valuation

Over the last 10 years, the highest EV/EBIT multiple that Mystar traded at was below 4. The stock seems to either stay in low single digit or even occasionally negative multiples. Recent EV/EBIT multiple is about 1.6.

Frankly, for a medium quality, small (and boring) business with consistent profitability and free cash flow like Mystar, 6 times EV/EBIT probably ought to be fair value. That said, for catalyst seeking investors, there are none. As of the last share repurchase, Itochu no longer owns any Mystar shares. Perhaps if Bank of Chiba (TSE: 8331) is inclined to sell its 4.42% stake, things might be different. Given that the last share repurchase was extrinsically encouraged, I don’t see any reason to believe that Mystar would initiate a repurchase on its own.

To be fair, Mystar share price has appreciated from about 300 yen per share back in 2009/2010 to about 800 yen today (~10% ish investment CAGR). Despite this, the company’s EV/EBIT multiple, with the exception of 2009/2010, has gone roughly nowhere (and recently even lower). This is likely attributable to some combination of share buybacks and recent increase in revenues (operating performance hasn’t noticeably improved).

I don’t see compounder characteristics in Mystar. However, patient investors with diversified long-term portfolios may find a place for Mystar’s medium quality, not-particularly-exciting business for a low single digit EV/EBIT. I estimate fair value to be around 1,300 yen per share currently vs. today’s price of 790 yen or so (May 29, 2018). This equates to a 64% upside with no reasonably determinable timetable for fair value realization. For context purposes, however, we can use a three year timeline and estimate investment CAGR at 18.1%. On a five year timeline, investment CAGR is at 10.5%.

The bottom line

Mystar Engineering is a medium quality business with medium level prospects trading at an attractive price. Though I estimate fair value to be around 1,300 yen per share (vs. May 29, 2018 790 yen per share), there are no clear catalysts for share price appreciation going forward. Therefore, the investment is only appropriate for patient investors with a long-term diversified portfolio. Depending on how long it takes for fair value realization, Mystar may deliver 18.1% (3 years) or 10.5% (5 years) investment CAGR.

 


Kenkyo Investing
Kenkyo Investing

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