Thinking Points

  • Joban Kaihatsu (TSE:1782) is a mid-tier construction and civil engineering company with a strong presence in the Tohoku region of Japan, where the 2011 earthquake hit.
  • As a result of the earthquake, the company delivered unusually strong business performance over the last 7 years.
  • With the Japanese government closing down reconstruction efforts, however, business performance is likely to revert to normalized levels.
  • At today’s 5,400 yen per share price, Joban Kaihatsu trades at a negative 0.5x EV/EBIT multiple (adjusted). Even assuming normalized business performance, the company trades at a discount.
  • Overall, investors can expect a three year investment CAGR of between 10.7% and 19.8%. As a warning, however, investors should keep in mind there are no catalysts that would positively shift investor sentiment. And the reversion to normalized business performance may serve as a negative catalyst, potentially making price appreciation difficult.

Introduction

Joban Kaihatsu (TSE: 1782) is a construction and civil engineering company based in Iwaki, Fukushima prefecture in the northeastern region of mainland Japan. The company operates through five segments: Construction, civil engineering, environmental, real estate, and other.

Source: Company filings


Headquartered about 65 kilometers (40 miles) south of the Fukushima Daiichi Nuclear Power Plant, Joban Kaihatsu is among the construction companies that have benefited from the 2011 Tohoku earthquake reconstruction projects.

The business & environment

Joban Kaihatsu’s roots can be traced back to 1884, when Joban Kosan, a coal mining company, was established. In 1960, the construction and civil engineering arm of Joban Kosan was spun off, marking the birth of Joban Kaihatsu. Joban Kosan, now mainly operating a resort in Fukushima, is still Joban Kaihatsu’s largest shareholder with a 12.8% stake.

As the segment revenue chart above shows, much of Joban Kaihatsu’s business is in construction and civil engineering. The Japanese construction industry, after nearly a two decade decline, started showing signs of recovery. To be sure, the industry still faces serious headwinds, like a severe labor shortage, for example.

Meanwhile, Joban Kaihatsu’s business performance over the last 7 years has been spectacular, mainly due to the 2011 Tohoku earthquake reconstruction projects.

Source: Company filings


Prior to 2010, the construction and civil engineering segments were combined. Between 2011 and 2018, Joban Kaihatsu’s revenues grew from 10,495 million yen ($95.8 million USD) to 21,555 million yen ($196.8 million USD), or a 7 year CAGR of 10.8%. Meanwhile, the Japanese construction industry as a whole grew at a 4.1% CAGR during the same time period:


Source: Japan Federation of Construction Contractors (Japanese), translation by Kenkyo Investing


Joban Kaihatsu’s 7-year 10.8% revenue CAGR starts to make more sense when narrowing down the scope to the Tohoku region, where the 2011 earthquake hit. Between 2011 and 2017, Tohoku regional construction investment grew from 3.61 trillion yen ($33 billion USD) to 6.09 trillion yen ($55.6 billion USD), or a 6-year CAGR of 9.1%. In fact, construction in the region peaked in 2015 and started slowing down as earthquake reconstruction progressed.


Source: Tohoku Ministry of Economy, Trade, and Industry (Japanese), translation by Kenkyo Investing


Even without the reconstruction projects, however, the Japanese construction industry has remained strong in recent years. Operating margins, for example, have grown considerably since the 2008-2010 global financial crisis.


Source: Japan Federation of Construction Contractors (Japanese), translation by Kenkyo Investing


Using the categorization of the Japan Federation of Construction Contractors, Joban Kaihatsu would be considered a mid-tier construction company (Invested Capital between 100mm – 1,000mm JPY). 2016 average operating margins for Japanese mid-tier construction companies came in at 4.8%. Meanwhile, Joban Kaihatsu recorded operating margins at 9.4% (in 2016), even higher than the average of large construction companies.

Source: Company filings


Source: Company filings


The Japanese government set 2021 as the target end date for the Tohoku earthquake reconstruction projects. Major construction focused on the first five years (2011~2016). During this period, the number of evacuees in the area declined from 470,000 people to 171,000 people. As of November 2018, the same figure has further declined to 54,000. Shortly after the earthquake, the government had setup 124,000 temporary houses. Since then, people have started moving out. As of December 2017, there are less than 19,000 temporary houses still in use.

Overall, the reconstruction projects are winding down and appear to be on track to close by the government’s target end date. For this reason, it is likely that Joban Kaihatsu’s business performance will weaken over the next few years. With that said, projects awarded have remained at elevated levels:

Source: Company filings


For fiscal 2019, management is guiding for 21,000 million yen ($191.7 million USD, -2.6% YoY) in revenues and 1,500 million yen ($13.7 million USD, -32.2% YoY) in operating income.

Shareholders

As of Q2 fiscal 2019 (ending September 30th, 2018), Joban Kaihatsu had 785,000 shares issued and 966 shares in treasury, putting outstanding shares at 784,034.

Here are the major shareholders:

Source: Company filings and Nikkei


As mentioned earlier, Joban Kosan, the company that Joban Kaihatsu was originally spun off of, still remains the largest shareholder. At the same time, Joban Kaihatsu is the largest shareholder in Joban Kosan.

There are no equity compensation plans for management.

Financials & Valuation

  • Joban Kaihatsu has a long history serving Fukushima prefecture and the greater Tohoku region.
  • In the 6 years leading up to the 2011 Tohoku earthquake, the company cumulatively generated less than 1% operating margins. In recent years, thanks to reconstruction efforts, margins have expanded to 10+%.
  • Although strong business performance ought to continue for a few more years, the Tohoku region is almost fully reconstructed and the Japanese government is set to end efforts by 2021.
  • On an adjusted basis, Joban Kaihatsu trades at a negative 0.5 EV/EBIT at today’s 5,400 yen per share price. Even after applying assumptions in line with normalized business performance, the company still appears undervalued.
  • Investors can expect a three year investment CAGR of between 10.2% and 19.8%. With that said, it’s important to keep in mind that there are only negative catalysts in sight, and price appreciation may prove difficult.

Joban Kaihatsu’s last 7 years of strong business performance is largely a function of the 2011 Tohoku earthquake reconstruction projects. Prior to the earthquake, the company was generating less than 2% operating margins. Although Japan’s economy has strengthened in recent years, it’s likely that Joban Kaihatsu’s operating performance would scale down as reconstruction efforts come to an end.

There are several things to note about Joban Kaihatsu’s balance sheet. First the company has a healthy cash balance of 5,114 million yen ($46.7 million USD) compared to total liabilities which amount to 7,339 million yen ($67 million USD). Additionally, the company holds 1,585 million yen ($14.5 million USD) in equities, which isn’t listed under current assets, but under other long term assets. Overall, the company has a healthy 0.53 equity to asset ratio.

When looking at a Japanese company with a long history like Joban Kaihatsu, its land assets are often listed on the balance sheet far below market prices. In the case of Joban Kaihatsu, however, this isn’t true. The company is one of a few that took advantage of a 1998 law which allows companies to reassess asset values to better reflect market prices. Hence, the company’s land holdings are more or less recorded in line with current prices.

As far as valuation metrics go, Joban Kaihatsu trades for an unadjusted EV/EBIT of 0.2x at today’s 5,400 yen per share price. There are two key adjustments that are necessary: including equity holdings in the EV calculation and replacing EBIT with normalized EBIT.

When including equity holdings, Joban Kaihatsu’s enterprise value is negative 1,208 million yen (-$11 million USD), putting adjusted EV/EBIT at negative 0.7.

Determining normalized EBIT is tricky. In the 6 years leading up to the 2011 earthquake, Joban Kaihatsu’s annual revenues averaged out to 13,000 million yen ($119 million USD), with operating margins just shy of 1% over the same time period. Today, construction companies of similar size are generating 4.8% operating margins.

With this in mind, we’ll layout two scenarios: operating margins at 0.8% and 4.8%. In both cases, the assumptions are normalized revenues at 13,000 million yen ($119 million USD) over the span of 3 years and a fair value of 2x adjusted EV/EBIT. Investing in Joban Kaihatsu at today’s 5,400 yen per share price, three year investment CAGR would look like the following:

Although Joban Kaihatsu’s business performance is clearly temporarily elevated, the company trades at a discount to fair value even when considering a normalized environment. With that said, it’s important to keep in mind that Joban Kaihatsu doesn’t have any hard catalysts that would drive a positive shift in investor sentiment. In fact, the earthquake reconstruction projects coming to an end would presumably lead to a decline in revenues and normalized operating margins, which may serve as a negative catalyst. From a behavioral point of view, price appreciation to fair value may prove difficult.

The bottom line

Joban Kaihatsu is a mid-tier construction and civil engineering company with a strong presence in the Tohoku region of Japan. After a major earthquake hit the region in 2011, construction investment remained elevated. As a result, Joban Kaihatsu delivered unusually strong business performance over the last 7 years. With the Japanese government set to close out reconstruction efforts, the company’s business performance will likely settle back to normalized terms. Interestingly, at today’s 5,400 yen per share price, Joban Kaihatsu trades at a negative 0.5x EV/EBIT multiple (adjusted). Assuming fair value at 2x EV/EBIT while applying normalized revenue and operating performance, investors can expect a three year investment CAGR of between 10.7% and 19.8%. As a warning, however, investors should keep in mind that there are no hard catalysts to drive a positive shift in investor sentiment. Instead, the company’s performance reverting to normalized figures may even serve as a negative catalyst.


Kenkyo Investing
Kenkyo Investing

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