Thinking Points

  • Yokota Manufacturing (TSE: 6248) is a niche fluid control solutions company delivering industry-leading business performance.
  • The company’s niche-focused business strategy positions it well for consistent business performance while also deterring institutional investors by keeping the company small.
  • Patient investors seeking stable dividends and continued business performance may expect a 3-year investment CAGR of between 6.2% and 13.5% inclusive of dividends, but should be prepared to hold the stock indefinitely (while collecting dividends) in the event that the stock price does not appreciate meaningfully.

Introduction

Yokota Manufacturing (TSE: 6248) is a niche fluid control solutions company based out of Hiroshima, Japan. In simple terms, the company manufactures and sells specialty pumps and valves. Yokota got its start in 1948 when the Yokota brothers started researching, developing, and selling pumps. In 1952, the brothers successfully developed a self-priming centrifugal pump with water-air separating mechanism. In 1953, they formally commenced business operations as Yokota Manufacturing.

 

Business Operations

Yokota does not report business performance by segment. The whole company operates as one business line. This includes pumps, valves, service parts, and maintenance. Though Yokota’s products are highly technical and specialized, an elementary understanding of pumps ought to be enough to grasp the idea of the company’s value proposition. To get an elementary understanding of pumps, I suggest reading a little bit about self-priming pumps here.

Taking a quick look at Yokota’s list of customers, it becomes immediately clear that the company offers a wide variety of solutions. Industries range from food processing to construction to chemicals, gas, power generation, and more.

Light reading of technical material on self-priming pumps (as linked above) makes it clear that air/water mixture, flow, and pressure play a big part in pump mechanics. Common problems with pumps are wear (i.e., hard material [like sand] mixed in with liquid), corrosion (i.e., pumping acidic/alkaline liquids), and stoppages (liquid stops flowing).

I won’t go into technical details, especially since I’m not qualified to do so. However, Yokota develops its own material (like its wear/corrosion resistant stainless steel alloy), has international patents, and a list of clients from a wide variety of industries. This suggests a level of technical expertise often seen in small, niche Japanese manufacturers.

What’s particularly interesting about the company is that it does not mass produce any of its products. In fact, Yokota positions itself as a “boutique manufacturer”, specifically targeting niche markets. This is mentioned in the company’s annual filing under its mid-to-long term management strategy description.

 

Competition

It’s difficult to compare Yokota with other pump manufacturers, mainly because Yokota positions itself to avoid competition. I am inclined to think this is a (very) good thing. It’s fair to say we can’t reasonably expect rapid, or any material top line growth from Yokota because of this. In the same breath, however, the small lots and niche specialization means that margins ought to be stable.

With that said, there are a little over 20 publicly traded companies involved in pump manufacturing of some sort in Japan, including giants like Hitachi (TSE: 6501), Mitsubishi Electric (TSE: 6503), Kubota (TSE: 6326), Kawasaki Heavy (TSE: 7012), etc.

The following are pump-focused companies by largest to smallest market cap (as of June 15, 2018):

  • Ebara (TSE: 6361),
  • Nikkiso (TSE: 6376),
  • Tsurumi Manufacturing (TSE: 6351),
  • Iwaki Pump (TSE: 6237),
  • Torishima Pump (TSE: 6363),
  • Teikoku Electric (TSE: 6333),
  • Tacmina (TSE: 6322),
  • DMW (TSE: 6365)

Ebara’s market cap is the highest at 359,252 million yen ($3.25 billion USD). Among these pump-focused companies, Yokota has the smallest market cap at 2,141 million yen ($19.4 million USD). At the same time, Yokota delivers the strongest business performance. The company marks the highest gross margins, operating margins, and Greenblatt ROIC among all the companies listed above, mostly by a large margin.

Comparing historical metrics of all companies would be messy, so I picked out the two closest competitors in terms of business performance: Teikoku Electric and Tacmina.

Source: GuruFocus, chart created by author

To give you an idea as far as scale goes, Teikoku and Tacmina revenues are over 10 times and 4 times that of Yokota’s 1,700 million yen ($15.5 million USD) per year or so, respectively.

As a reference, Teikoku’s market cap is at 29,070 million yen ($263 million USD) and Tacmina is at 12,582 million yen ($114 million USD).

 

Financials & Valuation

Again, we will compare Yokota with Teikoku and Tacmina.

Tamina’s balance sheet isn’t particularly healthy or unhealthy, with a 0.62 equity-asset ratio. In terms of capital efficiency, it is probably most optimized among the three companies. Meanwhile, Yokota and Teikoku both have net-cash positive balance sheets, with an equity-asset ratio of 0.82 and 0.77, respectively.

Despite Yokota’s considerably smaller size, the company has a larger net-cash position than Teikoku. Presumably, this means the company can stand to offload some of its cash, especially considering Yokota’s overall superior business performance compared to peers.

Interestingly, Yokota has the lowest EV/EBIT ratio among the pump-focused companies listed above. While I have no tangible evidence as to why, I would guess that the company is too small and illiquid for most institutional investors to consider.

Source: GuruFocus, chart created by author

 

According to Nikkei, Teikoku has a healthy mix of financial institutions (24.3%), other institutions (16.4%), foreigners (26.5%), and individuals (29.1%) as shareholders as of March 2018. In comparison, Yokota’s ownership is heavily skewed toward individuals (87%), with financial institutions (6.7%), other institutions (2.9%), and foreigners (0.4%) accounting for considerably smaller ownership. Tacmina is similar to Yokota. Both companies have heavy founding-family ownership.

The Yokota family combined owns at least 41.95% of shares. This includes the CEO, who is also the board chairman’s little sister’s husband. Another 5.11% is owned by a Yokota employee organization.

The industry standard EV/EBIT multiple today appears to float around high single digits. It’s also worth noting that the company maintains a historical dividend payout ratio of about 30%. Dividend yield is 2.62% currently. The increase in share count in recent years is mostly a function of the company’s 2013 IPO. The company hasn’t issued any stock options.

With few growth prospects and a business strategy that keeps the company small, I wouldn’t put more than a 6 times EV/EBIT multiple on Yokota, even with the excellent business performance. This is more or less a heuristic and the reason is structural: It’s unlikely for Yokota to scale enough to catch the interest of institutional investors. With less money available on the market for Yokota stock, price appreciation could be slow or even non-existent. For investors seeking stable dividends and consistent business performance, Yokota is perfect. For catalyst-seeking investors, avoid Yokota. At best, Yokota is worth 6 times EV/EBIT, but appropriate fair value multiple is between 4 and 6 times EV/EBIT. This would be equivalent to a share price of between 1,280 yen and 1,575 yen based on fiscal 2019 guided EBIT and assuming today’s balance sheet.

Again, Yokota’s strategy, which is structured for superior business performance, also keeps the company small and the stock illiquid. It’s difficult to determine how soon (if ever) the price would appreciate. Assuming a 3 year investment horizon, investment CAGR would be between 4.1% and 11.6% exclusive of dividends and 6.2% to 13.5% inclusive of dividends at 26 yen per share per year.

 

Few risks

Yokota’s niche focus requires a higher level of expertise to execute well compared to having several product lines with mass production. This is largely because custom project-based demand requires flexibility. Though the company is working toward automation, it still relies on seasoned talent.

Nepotism may be an issue as well. That said, the family-centered business is a double-edged sword. With no information available on employee feedback sites like Kaisha-no-Hyoban, it’s difficult to gauge from the outside whether the family-member CEO strategy is good or bad.

 

The bottom line

Yokota’s niche focused business strategy positions the company well for industry leading business performance, but also makes it difficult to scale. This makes it difficult for institutional investors, who tend to have large position sizes and liquidity requirements, to buy the stock. This also makes it difficult for the price of the stock to appreciate. Patient investors seeking stable dividends and continued business performance may expect a 3-year investment CAGR of between 6.2% and 13.5% inclusive of dividends, but should be prepared to hold the stock indefinitely (while collecting dividends) in the event that the stock price does not appreciate meaningfully.


Kenkyo Investing
Kenkyo Investing

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