Thinking Points

  • Sanko Sangyo (TSE: 7922) primarily manufactures specialty printed adhesive products and secondarily manufactures touchscreen related products.
  • The company was once a solid business generating stable profits, but was late shifting to higher value added products, finding itself in heavy price competition and generating a 10-year cumulative operating loss.
  • Management has laid out an aggressive plan to turn the company around, investing what’s equivalent to a third of shareholder’s equity over the next six years.. While sensible, the plan appears to leave investors with a still mediocre-at-best business.
  • Overall, the operating business is too poor to assign any real value to and management’s medium term plans are too aggressive to see the company as an asset play. Reserving valuation for now.
  • Interested investors should pay attention to whether the company moves into higher margin adhesive business (ex. Medical applications) or decides to sell its Tokyo headquarters.

Introduction

Sanko Sangyo (TSE: 7922) primarily manufactures specialty printed adhesive products, like stickers and labels. More recently, the company has shifted focus on manufacturing touchscreen related products. In 2018, stickers and labels accounted for 53% of revenues while touchscreen related products accounted for 47%.

Source: 2018 presentation


The company has three factories in Japan, along with factories in China, Malaysia, Thailand, Taiwan, and Vietnam. Touchscreen related products are mainly produced in Japan and China while stickers and labels are produced in all of the countries.

The business & environment

Sanko Sangyo’s roots can be traced back to 1951, when Seizou Tsuchida founded Sanko Tsusho, a trading company established to sell 3M’s (NYSE: MMM) Scotchlite reflective products (commonly used for traffic signs). In 1960, the group disbanded, and Seizou founded Sanko Sangyo, using Japanese materials to produce labels and stickers for home appliance makers and automotive companies.

The company operated out of its one Tokyo headquarters office at first, but set up a sales office in Osaka (1962), then in Nagoya (1972). By 1985, Sanko had four factories in Japan. After that, the expansion in Japan slowed down and the company started investing abroad, starting with Malaysia in 1988. Today, the company has three factories in Japan along with factories in China, Malaysia, Thailand, Taiwan, and Vietnam.

Though Sanko Sangyo, with an early presence in Asia Pacific, was able to take advantage of the manufacturing boom in the region, the company was late to shift its product mix. Price competition among basic products like stickers and labels intensified. Toward the late-2000s, the company’s profitability started to decline. In fiscal 2009, along with the global downturn, the company fell into the red.

From fiscal 2009 on, the company has either delivered losses or razor thin operating margins. Sanko started focusing more on touchscreen related products in fiscal 2011. It’s been a long road, with touchscreen related products accounting for 14% of revenues in 2011 and 47% in 2018. In 2018, the company delivered operating margins above 1% for the first time in 11 years.

Source: Company filings, chart created by author


Going forward

Sanko management notes that the touchscreen related business tends to have a short lifespan, with end products like smartphones having new models releasing every year. While fiscal 2018 operating performance was the best the company has seen in over a decade, it was largely driven by the touchscreen business.

In its medium term plan, which spans between fiscal 2019 and 2021, the company plans to build a solid business foundation that can deliver a consistent 200 million yen ($1.8 million USD) in operating income. Sanko management plans on achieving this through continual focus on touchscreen, building sticker and label business outside of electronics industry, and stabilizing ASEAN operations (particularly Thailand and Vietnam, which are still new (2015, 2018 respectively) and not yet profitable). Management projects this will require 1,000 million yen ($8.9 million USD) in capital investment.

In the next medium term plan, management is expecting 1,000 ~ 2,000 million yen ($8.9 million ~ $17.8 million USD) in capital investment, mainly going towards technological development in Japan and ASEAN expansion.

Here are the financial projections:

Source: 2018 presentation


To be sure, Sanko has guided a return to consistent profitability in its medium term plan for over a decade now. While the most recent medium term plan is considerably more detailed than the previous plans (which were basically just financial targets), even if the company achieves these targets, the operating business is still worth only a modest amount. Capital expenditures will exceed operating income for the foreseeable future, especially with management basically projecting about 350 million yen ($3.1 million USD) in annual capital expenditures over the next 6 years (on the low end) to build a business that can consistently drive 200 million yen ($1.8 million USD) of operating income.

Shareholders

As of Q2 2019, (ending September 30th, 2018), Sanko had 7,378,800 shares issued and 1,185,857 shares in treasury, leaving outstanding shares at 6,192,943.

Here are the major shareholders:

Source: Company filings, Nikkei


While I was unable to trace each individual major shareholder back to the founding family (Tsuchida family), a company of Sanko Sangyo’s size often has considerable family influence.

The company offers no equity compensation and has no stock options issued.

Financials & Valuation

  • Sanko Sangyo’s operating business took a turn for the worse soon after price competition intensified for commoditized products in the Asia Pacific region (late-2000s). The global downturn didn’t help either.
  • As it currently stands, management plans to spend up to 3,000 million yen ($26.6 million USD) over the next 6 years to build a business that can consistently generate 200 million yen ($1.8 million USD) in operating income.
  • The company has guided for stable profitability in every medium term plan over the last decade, but has so far been unsuccessful at delivering. It is likely best to assign a 0 (or even negative) value to the operating business as a realistic assessment.
  • Still, the company holds significant land. Judging by recent history, management is open to unloading assets. Unless
  • In short, Sanko’s operating business quality is poor and management is ready to invest what’s equivalent to one-third of shareholder’s equity (~3,000 million yen) into building a mediocre business. The planned capital  investment is too heavy to view the company as an asset play and the operating business is currently worth less than 0. No valuation for now.

Recent price hike

Sanko’s net current asset value is 4,759 million yen ($42.2 million USD) which puts NCAV per share at 769 yen. The company’s shares currently trade at 454 yen (December 7th, 2018 close).

Source: Google Finance


Interestingly, the stock price spiked to ~750 yen per share in March/April of 2018. According to Kabutan, a popular stock market news site, this was likely because investors expected retail demand for IC chips to considerably increase over the coming years. And Sanko Sangyo is well positioned to produce IC chips for retail.

Though the convenience industry has effectively announced the nationwide use of IC chips by 2025, one of the conditions for implementation is that the IC chip costs less than 1 yen per piece. This has proven difficult so far. A 2017 Nikkei BP article noted that unit cost is 10 yen on the low end. Even if the market for IC chips is projected to expand greatly and Sanko joins the movement, it’s still a long way from profitability today.

Land holdings

The fiscal 2018 long form filings show the book value of Sanko’s land assets at 1,233 million yen ($10.9 million USD). The market value of the company’s Tokyo HQ alone is worth more than that at an estimated 1,600 million yen ($14.2 million USD). Moreover, the company owns land in Nagano and Saitama prefectures that are worth about 59 million yen ($520K USD) and 111 million yen ($1 million USD), respectively. Sanko also has a factory in Osaka, but does not own the land.

In its 2018 presentation, the company noted that its sticker producing functions in Japan will be consolidated into the Nagano factory over the medium term. Seeing that the company sold its Honan factory (Tokyo) in fiscal 2017, it’s clear that management is at least open to selling off assets. With that said, unless Sanko decides to sell its Tokyo HQ, the business impact of an asset sale is immaterial.

As a reference, the Tokyo factory’s book value in 2016 was 292 million yen ($2.6 million USD), 213 million yen ($1.9 million USD) of which was land. The company sold this for 291 million yen ($2.6 million USD).

Valuation

As with many deep value stocks, Sanko’s balance sheet health is currently impeccable. With that said, the operating business has generated more losses than profits over the last decade. Though it seems management is steering the company in the right direction for the right reasons, a best case scenario of achieving all of its medium term targets still leaves investors with a mediocre operating business.

Moreover, management’s determination to invest heavily (~3,000 million yen, or roughly one-third of current shareholder equity) over the next six years makes it that much more difficult to view the company as an asset play. For this reason, I’ll reserve valuation for Sanko and note that it is likely best to avoid investing in the company at this point.

Interested investors ought to be on the lookout for the company to move into higher margin adhesives, in the medical field for example.

The bottom line

Sanko Sangyo was once a solid sticker and label production business, driving steady profits and proactively investing in overseas operations before it was the norm. With that said, Sanko was late shifting to higher value-add products, which steered the company straight into intense price competition in the Asia Pacific region. While the company holds valuable assets, management is eager to aggressively invest in the current operating business to turn things around. Overall, the company is moving in the right direction. But with a poor operating business and aggressive capital investment plan, it’s likely best that investors avoid investing in Sanko Sangyo for now.


Kenkyo Investing
Kenkyo Investing

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