Thinking Points

  • NKK Switches (6943) is a well-established industrial switch manufacturer with manufacturing facilities in Japan, China, and the Philippines.
  • Since its current CEO took the helm in 2003, the company has been focused on global expansion, but with mixed results.
  • With a commoditized offering, the business quality is mediocre at best. Although the company is shifting its product-oriented business to a solution-oriented one, this effort has just begun.
  • At today’s price of 5,300 yen per share, NKK trades for 61% of NCAV and 51% NCAV adjusted for investment security holdings.
  • Investors can expect an investment CAGR of between 5.7% and 14.3% over the next 5 to 8 years.

Introduction

NKK Switches (TSE: 6943) manufactures and sells a wide variety of industrial switches. Since its founding in 1951, the company maintained domestic manufacturing. It wasn’t until 2005 that NKK built its first overseas manufacturing facility in China. Today, the company manufactures out of Japan, China, and the Philippines and mainly sells to customers in the US, China, and Japan. Its segments are categorized by region:

Source: Company filings


Since Tomoshige Ohhashi, who is part of the founding family, assumed the CEO role in 2003, NKK started focusing on international business. As a part of the international focus, the company built manufacturing facilities in China and the Philippines, and renamed the company from Nihon Kaiheiki Kogyo to NKK in 2014.

The business & environment

NKK Switches strictly manufactures industrial switches and does not handle switches geared for consumer use. In an interview with Shacho Meikan (Japanese), Tomoshige explained that a higher degree of reliability is required for industrial switches, and that there is a considerable difference between manufacturing industrial switches and consumer switches.

The specific example he mentioned was with a hemodialyzer. Although the function of a switch is simple (i.e., on/off), there is a big difference between a hemodialyzer switch dysfunction and a light switch dysfunction. While one can create a life or death situation, the other has no meaningful negative consequences. With switches largely being a commoditized good, NKK Switches only handles industrial switches. Its switches are in a variety of applications like: Information communication equipment, satellites, computers, factory automation equipment, aerospace equipment, rail, shipping, medical, and more.

Here are some of the products NKK Switches manufactures:

Source: Company website


NKK Switches’ key manufacturing facilities are in Japan, China, and the Philippines. The company built its first foreign manufacturing facility in 2005, shortly after Tomoshige became CEO in 2003. Expansion into the Philippines happened more recently in 2015 and is still a work in progress. Currently, foreign production accounts for 60% the company’s total production capacity.

The push for global expansion shortly after Tomoshige taking the lead isn’t a coincidence. Having worked for IBM previously, Tomoshige experienced a culture shock when he started working at NKK in 1996, commenting that NKK was a pure Japanese company.

Overall, global expansion has brought mixed results so far, with Japan revenues declined, US revenues up, and Asia revenues going from non-existent to relevant:

Source: Historical company filings


As with many Japanese manufacturers of commoditized goods, NKK Switch’s profitability is largely dependent on exchange rates and material costs.

Source: Historical company filings


More recently, the company is focusing on building a solutions business. Essentially what this means is that NKK goes one step beyond making switches, like customizing print, attaching a harness, or assembling the switch onto a panel.


Source: Company website (Japanese)


For fiscal 2019, NKK guided for revenues of 8,000 million yen ($73.1 million USD) and operating income of 500 million yen ($4.6 million USD). In H1 2019, the company delivered 3,962 million yen ($36.2 million USD) in revenues and 59 million yen ($540K USD) in operating income. The company noted that material price increases, labor cost increases in Japan/China, Philippine factory construction costs, and the US-China trade friction have negatively impacted business performance. With that said, the company hasn’t adjusted guidance downward for the full year.

Shareholders

As of Q2 2019, NKK had 842,520 shares issued and 19,532 shares in treasury, putting issued shares at 822,988.

Here are the major shareholders;

Source: Company filings and Nikkei


Big Bridge, which is a direct translation of Ohhashi, is the Ohhashi family’s fund. Collectively, the Ohhashi family owns 27.7% of outstanding shares.

There are no unexercised stock options or management equity compensation plans.

Financials & Valuation

  • NKK Switches is a long established industrial switch manufacturer focused on expanding globally.
  • Since Tomoshige took the helm in 2003, the company has built manufacturing facilities in China and the Philippines. Overseas manufacturing now accounts for 60% of NKK’s capacity.
  • While the expanded global footprint has converted into meaningful revenues outside of Japan, the company’s Japan revenues has declined considerably compared to a decade ago.
  • At today’s 5,300 yen per share price, NKK trades at 61% of NCAV, and 51% of NCAV after adjusting for investment security holdings.
  • Investors can expect an investment CAGR of between 5.7% and 14.3% over the next 5 to 8 years.

NKK Switches is an established industrial switch manufacturer looking to expand its presence overseas. Since Tomoshige, a former IBM employee, took the helm in 2003, NKK has extended its historically domestic manufacturing footprint overseas. Today, 60% of the company’s manufacturing capacity is outside of Japan, namely in China and the Philippines.

Since its global expansion, however, NKK’s Japan revenues has declined. Meanwhile, international revenues hasn’t grown enough to cover the decline. Still, the company remains mostly profitable. With that said, NKK’s business quality is mediocre at best, with a rather commoditized offering and labor rates, material prices, exchange rates, and trade deals dictating company profitability.

Unlike many long-established Japanese companies, NKK does not own a significant amount of land. It does, however, hold investment securities worth 1,350 million yen (12.3 million USD) as of fiscal 2018 filings (breakdown not available in quarterly filings).

At today’s 5,300 yen per share price, NKK Switches has a market cap of 4,362 million yen ($39.8 million USD). At the current price, NKK trades at 61% of NCAV and 51% of NCAV adjusted for investment security holdings. Much of NKK’s current assets are in cash and receivables, and the company can use some improvement in inventory-to-revenue, which has remained between 24~46% over the last 10 years.

Overall, NKK’s business is mediocre, but its price is attractive. There aren’t any imminent and material threats as far as existential threats go. Hence, it’s likely that NKK would trade at or above 80% – 100% NCAV in the future. Investors can expect an investment CAGR of between 5.7% and 14.3% over the next 5 to 8 years.

Source: Estimates by Kenkyo Investing


The bottom line

NKK Switches is a well-established industrial switch manufacturer with an expanding global footprint. Although the company is making an effort to shift from a product manufacturer to a solution-oriented business, its offering is mostly commoditized. The business quality is mediocre at best, but priced at an attractive 51% of adjusted NCAV. At today’s 5,300 yen price, investors can expect an investment CAGr of between 5.7% and 14.3% over the next 5 to 8 years.


Kenkyo Investing
Kenkyo Investing

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