Thinking Points

  • Tsubakimoto Kogyo delivers custom engineering solutions to customers.
  • Sister company Tsubakimoto Chain is a global share leader in industrial chains, accounting for ~30% of Tsubakimoto Kogyo’s purchase spending.
  • Current fair value share price is 5,300 yen compared to today’s 3,105 yen price. The company currently trades at a negative enterprise value. However, there are no immediately obvious catalysts to shift investor sentiment for the better.

 

Introduction

Tsubakimoto Kogyo (TSE: 8052) is engaged in the sale of power transmission, industrial equipment, and industrial materials. The company doesn’t actually manufacture anything. But you may have heard of its sister company Tsubakimoto Chain (TSE: 6371), a global leader in industrial steel chains, drive chains, power cylinders, and cam clutches, among other things.  

The founders of Tsubakimoto Kogyo and Tsubakimoto Chain are brothers. Both companies have a strong focus on engineering. While Tsubakimoto Chain is busy crafting products, Tsubakimoto Kogyo is busy selling and integrating them.

With that said, Tsubakimoto Kogyo is more than just a trading company – it develops industrial solutions too. Similar to system integrators in the IT world, Tsubakimoto Kogyo exerts its engineering aptitude by combining products to deliver custom solutions, often times for industrials. In short, Tsubakimoto Kogyo supports factory automation initiatives.

Source: Company website

 

Tsubakimoto Operations

It goes without saying that Tsubakimoto Kogyo is closely tied to its global leader sister company. Of the 85,431 million yen ($767 million USD) spent on purchasing in fiscal 2017, Tsubakimoto Chain accounted for 24,137 million yen ($217 million USD), or 28.3% of total.

Tsubakimoto Kogyo is exposed to all the cyclicality that comes with the automotive industry. Fortunately, the company doesn’t need to worry about factories being an expensive paperweight during downturns because it has none. What’s interesting, however, is that Tsubakimoto Chain fared better than Tsubakimoto Kogyo during the 2009/2010 downturn, even with the fixed assets.

The company positions itself as a general trading company for all things machinery and technology related. Tsubakimoto Kogyo’s segments are organized by region – Eastern Japan, Western Japan, and Overseas. However, the previous segmentation seemed more meaningful – Power Transmission, Industrial Equipment, and Industrial Materials. Here are revenues split out by the old segments for fiscal 2018:

 

Source: Filings

 

And here’s how segment sales have fared over the last ten years:

Source: Historical Filings

 

The company has over 5,000 customers with no single customer accounting for more than 10% of sales. What’s clear, however, is that Tsubakimoto Kogyo’s well-being is dependent on a healthy capex spending environment. Revenue dropped 29.3% between fiscal 2009 and 2010. The Industrial Equipment segment was hit particularly hard with a 35.6% drop, which was followed by a 21.4% YoY drop the year prior. Power Transmission segment revenues dropped by 30.1% between fiscal 2009 and 2010. In contrast, however, Industrial Material sales have remained remarkably consistent, and actually increased 1.2% between fiscal 2009 and 2010.

Since the company shifted to new segment reporting, which bases sales by region, it’s difficult to get a feel for margins by product type. Using fiscal 2011 data as a reference, operating margins are somewhere around ~3% for Power Transmission, ~2% for Industrial Equipment, and ~3% for Industrial Materials. At this point, revenues for Power Transmission had already recovered from the fiscal 2010 slump, but Industrial Equipment revenues were still at considerably lower levels.

More recently, Tsubakimoto Kogyo has taken its business overseas. The company didn’t disclose foreign sales figures until fiscal 2014 because it accounted for less than 10% of total sales prior to that (this is normal in Japanese filings). In fiscal 2018, overseas sales accounted for 13% of total.

 

Financials & Valuation

With the cyclical exposure, it’s probably best to look at Tsubakimoto Kogyo with a 10-year normalized environment in mind. The company hasn’t meaningfully grown when compared to pre-crash levels, both on the revenue or operating income level. Interestingly, fiscal 2018 revenues were pretty much in line with pre-crash levels while operating income came in 20% higher.

Source: Historical Filings

 

A flat average of the last 10 years of revenues is 83,231 million yen ($748 million USD) and operating income is 1,972 million yen ($17.7 million USD). The company is generally free cash flow positive, thanks to its people-heavy capex-light business. Fiscal 2018 free cash flow came in particularly high, mostly due to an increase in payables amounting to 10,370 million yen ($93 million USD) only partially offset by an increase in receivables of 6,354 million yen ($57 million USD). The fiscal year closing date landed on a weekend, which affected the wide gap in receivables and payables. Tsubakimoto Kogyo doesn’t carry an enormous pile of cash on its balance sheet like many other Japanese companies. In fact, equity-to-asset ratio has remained between 0.24 and 0.35 over the last 10 years.

The company currently trades at an EV/EBIT multiple of 1.7 unadjusted. However, EV would be negative 5,372 million yen ($48.3 million USD) if we treat the 11,359 million yen ($102 million USD) in shareholdings as cash. About 40% of shareholdings is in Tsubakimoto Chain.

Given the size, cyclicality, and growth prospects (or lack thereof) of Tsubakimoto Kogyo, I would assign a 4 times adjusted EV/EBIT multiple to the company. Using a “normalized” EBIT of 1,950 million yen ($17.5 million USD), this would translate into a current fair value share price of about 5,300 yen compared to today’s price of 3,105 yen. Fair value share price three years out ought to be around 5,900 yen using normalized revenue and operating income figures.

To be sure, management is guiding for fiscal 2019 operating income of 3,220 million yen ($28.9 million USD). One thing to note is that, despite the absurdly low valuation multiple, Tsubakimoto Kogyo share price can remain low for a long time. Besides being picked up as a factory automation play, there doesn’t seem to be a hard catalyst that would help swing investor sentiment.

 

The bottom line

Tsubakimoto Kogyo specializes in delivering custom solutions to manufacturing problems. The company doesn’t actually manufacture anything. Rather, it leverages its engineering aptitude and close ties with sister company Tsubakimoto Chain to deliver custom solutions for its customers. Overall, Tsubakimoto Kogyo is a medium quality business with a current fair value share price of about 5,300 yen vs. today’s 3,105 yen share price. There are no immediately obvious catalysts that would shift investor sentiment for the better in the near term.

 


Kenkyo Investing
Kenkyo Investing

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