Thinking Points

  • Kita Koudensha (SSE: 1734) is a power construction company with an equipment sales arm, servicing the Hokkaido (northernmost region) of Japan.
  • The company is operationally decent, with ties to Mitsubishi Electric (TSE: 6503), its largest shareholder, and Hokkaido Electric Power (TSE: 9509), its largest customer servicing all of Hokkaido.
  • After an earthquake hit Hokkaido in September 2018, the entire region blacked out as Hokkaido Electric’s main power plant was damaged and the company infrastructure couldn’t handle the power supply/demand imbalance.
  • At the current share price of 3,770 yen, Kita Koudensha trades at 0.55 P/NCAV. Over a conservative 5 to 8 year timeframe, investors can expect an investment CAGR of between 4.8% and 12.7%. This comes with the possibility of a 20+% CAGR if Hokkaido Electric spends heavily in the next couple years.

Introduction

Kita Koudensha (SSE: 1734) is a Hokkaido-based power construction company with an equipment sales arm. The company operates through four business segments: Indoor Wiring Construction, Power Related Construction, Residential Environmental Equipment, and Industrial Equipment.  With over 100 years of history, the Kita Koudensha maintains a strong presence in the Hokkaido region (northernmost Japan).

For its construction arm, Kita mainly takes on construction and maintenance projects related to commercial scale indoor wiring, power plants & substations, and power & communication lines. For equipment sales, the company handles everything from industrial power generation/transmission equipment, industrial machinery (gas turbine/diesel engine), and residential equipment (HVAC, boiler, pumps), and other miscellaneous equipment.

Revenue by segment for fiscal 2018 is below:

Source: Company filings

 

Before we get too far into this post, here’s a cautionary note: Kita Koudensha trades on the Sapporo Securities Exchange and is not listed on the Tokyo Stock Exchange. The stock is not only highly illiquid, but also difficult to purchase for foreign investors. If you’re interested in purchasing, you’ll likely need to pick up the phone and make a special arrangement with your broker.

 

The business & environment

Industry

First thing to note is that Kita Koudensha is located in Hokkaido, the northernmost and coldest prefecture in Japan:

Source: Google Maps

 

Sapporo City, the capital of Hokkaido, hosted the 1972 Winter Olympics. If the name sounds familiar, it’s probably because Sapporo is also a popular beer brand by Sapporo Holdings (TSE: 2501). This is where Kita Koudensha headquarters is located. The company is well known for its construction design and techniques in cold/snowy regions.

The Hokkaido Construction Newspaper compiled industry data for the prefecture. Construction project orders placed from 2001 through 2017 are below:

Source: Hokkaido Construction Newspaper (in Japanese)

 

Business Operations

Though the company technically operates through four segments, the nature of these segments can be simplified into two: Construction (indoor wiring, power related) and equipment sales (residential environmental, industrial equipment).

 

Construction

Kita Koudensha has taken on large scale projects including electrical installation work on Sapporo Dome, various tunnel lighting/power/disaster prevention/communication work, power transmission line (above & underground) construction, electrical work for Tomari Nuclear Power Plant, and more.

Source: Sapporo Dome (home to professional baseball team Nippon Ham – Fighters)

 

Hokkaido’s construction industry started strong in the 2000s, then saw a decline going into the 2008-9 crash. Since then, the industry has been on a recovery track, and Kita Koudensha’s recent business performance has been right in line with this:

Source: Company filings, compiled by author

 

Going into 2019, Kita Koudensha carried over a high level of Indoor Wiring related work. The Power Related segment, on the other hand, carried over a historically weak level of work. With that said, business performance will likely remain strong a few years out as an earthquake hit Hokkaido on September 6, 2018, shutting down the prefecture’s powergrid. Since the 2011 earthquake, which resulted in the Fukushima Nuclear Plant meltdown, the Japanese government has been pressuring power companies to strengthen its networks. Many of these companies have been slow to respond. Currently, Hokkaido heavily relies on Tomatoatsuma Power Plant, which supplies half of the prefecture’s power.

Hokkaido’s power is managed by Hokkaido Electric Power (TSE: 9509), usually referred to as Hokuden. Historically, Hokuden has historically contributed meaningfully to Kita Koudensha’s revenues:

Source: Company filings, compiled by author

 

To be sure, Kita Koudensha does not have a monopoly on Hokuden related construction work. In fact, Hokuden has controlling interest in Hokkaido’s largest electrical construction company: Hokkai Electrical (SSE: 1832). Hokuden related work accounted for 68.9% of Hokkai Electrical revenues in fiscal 2018. Nevertheless, Kita Koudensha’s Hokuden related business ought to come in elevated over the next couple of years as Hokuden figures out how to better balance power supply and demand.

Kita Koudensha adjusted H12019 guidance down from 5,700 million yen ($50.3 million USD) in revenues and negative 50 million yen (-$440K USD) in operating losses to 4,900 million yen ($43.3 million USD) in revenues and negative 180 million yen (-$1.6 million USD) in operating losses. The operating losses in the first half of the year isn’t particularly surprising as Japan operates on a April – March budgeting calendar and much of the work is completed towards the end of this cycle. The company made no changes to full year guidance of 14,000 million yen ($123.6 million USD) in revenues and 210 million yen ($1.9 million USD) in operating income.

The Indoor Wiring and Power Related segments accounted for 88.5% of revenues and 80.3% of operating income in fiscal 2018.

 

Equipment Sales

Mitsubishi Electric (TSE: 6503) is Kita Koudensha’s largest shareholder. As such, Kita Koudensha is Mitsubishi Electric’s sales agent for standard products and distributor for building power equipment, power generation & transforming equipment, and CVCF equipment (i.e., uninterruptible power supplies). In addition to equipment sales, Kita Koudensha provides maintenance services to two solar farms under the Residential Environmental Equipment segment.

The Residential Environmental Equipment and Industrial Equipment segments accounted for 11.5% of revenues and 19.7% of operating income in fiscal 2018.

 

Shareholders

According to the Q22019 short form filings (unaudited), Kita Koudensha has 650,000 issued shares and 19,060 treasury shares. This equates to 630,940 outstanding shares.

Here are the top 10 shareholders:

Source: Nikkei, MarketScreener, and company filings

 

Black Clover is a deep value focused investment fund based out of Dubai. Shungo Sakamoto, the fund manager, is Japanese. I had the pleasure of exchanging a couple of emails with him as a part of researching Kita Koudensha.

No equity compensation offered.

 

Financials & Valuation

Several key points to keep in mind about Kita Koudensha:

  • Kita Koudensha is traded on the Sapporo Securities Exchange and not on the Tokyo Stock Exchange, making the stock difficult to purchase. Funds with liquidity requirements may want to avoid.
  • There is nothing remarkable or terrible about the operating business, but business performance ought to be strong in the near term due to high regional exposure to Hokkaido and recent earthquake in the area.
  • Price to NCAV is at 0.55 using November 2, 2018 closing price of 3,770 yen per share and financials from Q22019 filings (unaudited).

Kita Koudensha is a perfectly okay business. That said, being listed on the Sapporo Securities Exchange and not on the Tokyo exchange means low liquidity and less opportunity for price movement. As with most Japanese net net stocks, it’s best to expect 5 to 8 years for price appreciation to happen. Using current financials, 80% NCAV would be around 5,500 yen per share and 100% NCAV would be 6,869 yen per share. Here’s a table calculating projected investment CAGR:

I put the 3 year investment timeframe in there as a reference. You can expect an investment CAGR of between 4.8% and 12.7%. If Hokuden decides to invest in an alternative power plant (currently operates 1 nuclear plant), Kita Koudensha’s business and stock performance ought to improve over a shorter time frame (i.e., 3 year time frame).

 

The bottom line

Kita Koudensha is an operationally decent company trading far below NCAV (P/NCAV of 0.55). Over a 5 to 8 year investment timeframe, the company ought to generate modest returns in the range of 4.8% to 12.7% annualized. This comes with the possibility of a shorter timeframe for share price appreciation if Hokuden makes sizeable investments.

 


Kenkyo Investing
Kenkyo Investing

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