Thinking Points

  • Kaneso (NSE: 5979) is an established construction materials maker that has remained profitable for over a decade, even through the global financial crisis.
  • Recent operating performance has been weak. This can largely be attributed to an increase in R&D expenditure.
  • Overall, the operating business quality is mediocre, but the company has accumulated significant cash over time, and owns land booked severely below market price.
  • Being traded on the Nagoya exchange with 69.5% founding family ownership, however, liquidity is low.
  • Investors comfortable with illiquidity can expect to gain an investment CAGR of between 6.1% and 14% over the next 5 to 8 years, while getting paid a current 3.4% dividend yield.

Introduction

Kaneso (NSE: 5979) is a manufacturer of metal products used in construction like manhole covers, drains, castings, and expansion joints. The products are seen in buildings, landscaping, welfare facilities, and more. Kaneso operates through a single segment and has four revenue categories: Cast iron equipment, steel equipment, finished hardware, and other.

Source: Company filings


Kaneso is a small company based out of Asahi-cho, just outside of Nagoya metro. As such, it is traded on the second section of the Nagoya exchange, and not cross-listed on the Tokyo exchange. Some investors may have difficulty trading its shares.

The business & environment

Kaneso’s business is dependent on a healthy construction industry. The last decade in construction have been challenging with a decline in public investment and an increasingly tight labor market. More recently, public investment has stabilized, but the labor situation remains challenging.


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


Kaneso, however, is effectively a construction materials company. Hence, increasing/stabilizing public construction investment is a tailwind. With that said, the company has been unable to increase operating margins.

Source: Company filings


This is likely because Kaneso is highly dependent on intermediaries for sales. Over 70% of annual revenues are generated through its top 20 customers, most of which are construction material wholesale intermediaries.

Kaneso’s products are mostly commoditized. In recent years, its R&D expenses have increased as the company develops higher-end value-added products like drains for food processing areas, earthquake resistant expansion joints, and various trench covers (anti-theft, noise-less, etc).

Source: Company filings


Put another way, if Kaneso had maintained historically average levels of R&D expenditures (~40 million yen/year), its operating income would’ve come in around 340 million yen ($3.1 million USD) in 2017 and around 359 million yen ($3.3 million USD) in 2018. This equates to operating margins of 4.6% and 4.8%, respectively, which is a fairly normal operating performance for Kaneso.

As far as sales mix goes, the long term trend is that Kaneso’s cast iron and steel equipment sales is declining while finished hardware sales has remained strong.

Source: Company filings


Interestingly, Kaneso remained profitable through the global financial crisis, and continues to consistently generate operating profits today. As long as the company can manage to keep current levels of revenue, it ought to continue generating profits.

For fiscal 2019, Kaneso guided for 7,700 million yen ($70 million USD) in revenues and 340 million yen ($3.4 million USD) in operating income. As of Q2 2019 (ending September 30th, 2018), Kaneso has delivered 3,326 million yen ($30.2 million USD) in revenues and 38 million yen ($345K USD) in operating income. The Japanese construction industry is generally busiest during the months leading up to April, when the Japanese government’s calendar (and budget) starts. Hence, the comparatively low level of revenues in the first two quarters is not a cause for concern.

Shareholders

As of Q2 2019 (ending September 30th, 2018), Kaneso had 1,440,000 share issued and 16,290 shares in treasury, putting outstanding shares at 1,423,710.

Here are the major shareholders:

Source: Company filings and Nikkei


The Kobayashi family is Kaneso’s founding family. Collectively, the family owns 69.5% of outstanding shares and have board seats, but no managerial positions.

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

Financials & Valuation

  • Kaneso is an established construction material maker that has remained small and profitable for over a decade. Though recent operating performance declined, much of it can be traced to an increase in R&D expenditures.
  • 62% of Kaneso’s assets are in the form of cash & equivalents. The company has a net cash position of 7,680 million yen ($69.8 million USD) compared to its current market cap of 6,279 million yen ($57.1 million USD).
  • Moreover, the company owns land which is recorded at a book value considerably below current market prices.
  • At today’s 4,410 yen per share price, Kaneso trades at 62.3% NCAV with an enterprise value of negative 3,357 million yen ($30.5 million USD).
  • Investors can expect an investment CAGR of between 6.1% to 14% over the next 5 to 8 years while collecting dividends currently yielding 3.4%.

Kaneso is an established construction material maker which has remained profitable for over a decade, even through the global financial crisis. Although recent operating performance appears weak on the surface, much of the decline can be attributed to increased R&D expenditure. Overall, the company maintains a mediocre, but profitable business.

There are two key factors that make Kaneso’s balance sheet attractive: cash and land.

The company has accumulated 9,549 million yen ($86.8 million USD) in cash & equivalents over the years. Additionally, Kaneso has 87 million yen ($790K USD) in long term investment securities. Net of this, the company has 9,636 million yen ($87.6 million USD) in cash & equivalents. Adjusted current assets is at 12,033 million yen ($109.4 million USD).

As for liabilities, Kaneso is debt-free with total liabilities adding up to 1,956 million yen ($17.8 million USD). Adjusted net cash is at 7,680 million yen ($69.8 million USD) and adjusted NCAV is at 10,077 million yen ($91.6 million USD). At today’s price of 4,410 yen per share, market cap is 6,279 million yen ($57.1 million USD), or 81.8% net cash and 62.3% NCAV.

Kaneso’s balance sheet shows 1,733 million yen ($15.8 million USD) in land, 1,482 million yen ($13.5 million USD) of which is the land its headquarters and factory sits on. This is estimated to be worth around 3,372 million yen ($30.7 million USD) when referencing government estimates of nearby land, which have been in-line with actual transaction prices.

With a mediocre but profitable business, large cash position, and underbooked land assets, Kaneso should be priced at a premium to adjusted NCAV. At today’s 4,410 yen per share price, investors can expect to gain an investment CAGR of between 6.1% and 14% over the next 5 to 8 years.

Source: Kenkyo estimates


Investors ought to keep in mind, however, that the stock trades on the less liquid Nagoya exchange, with 69.5% of shares owned by the founding family. Only investors comfortable with illiquidity should consider Kaneso. On a more positive note, the company has kept its payout ratio above 100% regularly over the last decade. For fiscal 2019, it’s set to payout 150 yen in dividends, which puts current dividend yield at 3.4%.

The bottom line

Kaneso is an established construction materials maker that has remained profitable for over a decade, even through the global financial crisis. Overall, the operating business quality is mediocre, but the company has accumulated significant cash over time, and owns land booked severely below market price. Being traded on the Nagoya exchange with 69.5% founding family ownership, however, liquidity is low. Investors comfortable with illiquidity can expect to gain an investment CAGR of between 6.1% and 14% over the next 5 to 8 years, while getting paid a current 3.4% dividend yield.


Kenkyo Investing
Kenkyo Investing

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