Thinking Points

  • Founded in 2011, First Corporation (TSE: 1430) is a new general contractor specializing in condo construction, but with a twist.
  • The company differentiates itself by getting involved in the development process, thereby strengthening its negotiating position with developers and gaining above-industry margins.
  • Business performance has weakened recently, however, with intense competition in securing land from the hotel industry. Although the hotel industry’s rush is expected to cool down, condo construction is also slowing down compared to the last few years.
  • At 775 yen per share, First Corporation trades at 2.5x EV/EBIT with a market cap of 10,353 million yen ($93.5 million USD).
  • Investors can expect a three year investment CAGR of 10%, inclusive of dividends, if First Corporation delivers performance in line with 2018.

Introduction

First Corporation (TSE: 1430) is a construction general contractor specializing in condo construction in the Tokyo and surrounding areas. The company was newly founded in 2011 with the help of construction holding company Iida Group Holdings’ (TSE: 3291) founder, and quickly made it to the public markets in 2015. First Corporation puts revenues into four different categories:

Source: Company filings


First Corporation’s business model comes with a twist. Although most general contractors bid against one another for work awarded by developers, First Corporation takes the initiative to find a piece of land to develop and propose a plan to developers. The company considers this model its competitive edge.

The business & environment

First Corporation is a general construction contractor founded in 2011 by CEO Toshiaki Nakamura with help from Kazuo Iida, founder of construction holding company Iida Group Holdings (TSE: 3291). The company started off by specializing in condo construction, but with a twist.

Normally in the construction industry, the real estate developer first secures land and plans a project. The company then puts the project up for bid by several general contractors. The general contractors compete with one another in providing bids. The developer then chooses the most competitive bid. As a result, profitability for general contractors are limited, and usually between 4 to 6%.

Instead of becoming another general contractor in the bidding war, First Corporation added a layer to the process. The company set up a team that researches land and creates development plans, a process which is normally done by developers. Moreover, this process generally takes about a month, but First Corporation pushes the timeline in order to improve its chances of securing land. As a result, the company completes its research and development plans in as little as 10 days.

First Corporation then proposes the project to a developer. If the developer is interested, then the land is secured and construction plans are negotiated. Unlike the usual bidding process, however, First Corporation owns the land and therefore has stronger bargaining power at the negotiating table. Of course, the project isn’t open for bidding by competing general contractors either, enabling First Corporation to secure above-industry margins.

Source: Company website, translation by Kenkyo Investing


General contractors with this sort of business model (called “Zochu” in Japanese) existed during Japan’s economic miracle, but have since disappeared after Japan’s bubble burst. With the last few years of construction trends showing signs of improvement for the first time in decades, however, First Corporation’s revival of the strategy has shown its effectiveness.

Here is a comparison of operating margins for mid-tier general contractors Haseko (TSE: 1808, largest condo construction company in Japan), Hazama Ando (TSE: 1719), Sonec (TSE: 1768), Mikikogyo (TSE: 1718), and Shinnihon Construction:

Source: GuruFocus


Shinnihon Construction recorded the strongest operating margins by far. This company takes First Corporation’s business model a bit further by being a full fledged developer and a general contractor. Shinnihon is a mid-tier developer/general contractor in direct competition with First Corporation.

Haseko, the largest condo construction company in Japan, also recently recorded higher margins than First Corporation. Coincidentally, it is the only other sizable general contractor focused on the Zochu business model. According to a 2017 interview with Media IR (Japanese), First Corporation generally does not compete with Haseko as First Corporation’s condo projects generally range between 30 and 300 units while Haseko works on major developments.

To be sure, not all of First Corporation’s work comes from Zochu. In many cases, the company is submitting bids and competing with other general contractors for work. In 2018, 26.4% of projects came from the Zochu approach. This figure was as high as 70% in 2017, before First Corporation started competing with the hotel industry in securing land.

Now, here is a brief explanation of First Corporation’s revenue categories. The Finished Work category is much like what is seen from any other general contractor, plain finished construction work. The Real Estate Sales category is revenue from First Corporation selling land for development to a developer, as a part of Zochu projects. The Collaboration category is the newest (since 2018) and most interesting. First Corporation is now collaborating with developers to sell finished properties. Perhaps the company will start having its own developments in the future.

Although First Corporation primarily operates in the Tokyo and surrounding areas, the company opened an office in Kyushu (western Japan) recently. In its 2018 earning presentation, the company expected that competition for land with the hotel industry will cool down. At the same time, condo construction starts in the Tokyo area are slowing down:

Source: Q2 2019 company presentation


For fiscal 2019, First Corporation guided 25,018 million yen ($226 million USD, +20.2% YoY) of revenues and 2,418 million yen ($21.8 million USD, +7.6% YoY) of operating income. As of Q2 2019 (ending November 30th, 2018), this was adjusted down to 21,499 million yen ($194 million USD, +3.3%) in revenues and 1,995 million yen ($18 million USD, -11.3% YoY) in operating income after posting weaker than expected performance.

The company still maintains its three year net income targets from 2018:

Source: Q2 2019 presentation, translated and modified by Kenkyo Investing


Shareholders

As of Q2 2019 (ending November 30th, 2018), First Corporation had 13,358,540 shares issued and 31 shares in treasury, putting outstanding shares at 13,358,509.

Here are the major shareholders:

Source: Company filings and Nikkei


The Nakamura and Iida families combined control 38.6% of outstanding shares. Additionally, there are 10,000 shares worth of unexercised stock options.

Financials & Valuation

  • First Corporation is a new general contractor specializing in condo construction, but with a twist.
  • The company differentiates itself by getting involved in the development process, thereby strengthening its negotiating position with developers and gaining above-industry margins.
  • Business performance has weakened recently, however, with intense competition in securing land from the hotel industry. Although the hotel industry’s rush is expected to cool down, condo construction is also slowing down compared to the last few years.
  • At 775 yen per share, First Corporation trades at 2.5x EV/EBIT with a market cap of 10,353 million yen ($93.5 million USD).
  • Investors can expect a three year investment CAGR of 10%, inclusive of dividends, if First Corporation delivers performance in line with 2018.

Founded in 2011, First Corporation is a newcomer in the construction scene, quickly establishing its presence as a specialized condo construction general contractor. The company brought back a business model often used during Japan’s economic miracle in order to strengthen its negotiating position with developers. As a result, the company has delivered above-industry margins, along with a few other peers with a similar approach.

Although the company was on a fast growth track since its founding, it faced stiff competition from the hotel industry when securing land in 2018. Hence, business performance came in weaker than expected, and while the hotel industry is expected to cool down, condo construction is expected to slow down as well. Still, the company is projecting growth, explaining that it only has a 2% market share in condo construction  in the Tokyo & surrounding areas.

For valuation purposes, however, it is best to assume no growth or negative growth as the industry slows down. To be sure, an increase in the rate of Zochu projects could result in a scenario where revenues decline but profits increase.

At today’s 775 yen per share, First Corporation trades for 2.5x EV/EBIT with a market cap of 10,353 million yen ($93.5 million USD). No adjustments are needed. Generally speaking, a healthy and profitable company of First Corporation’s size ought to trade between 2 and 6x EV/EBIT. Considering that First Corporation is in construction, it is probably best to assume that fair value is on the lower half of the range.

Assuming the company maintains revenues around 20,000 million yen ($181 million USD), operating income around 2,000 million yen ($18 million USD), and the EV/EBIT multiple expands to 3 over the next three years, investors can expect an investment CAGR of about 10%. This is a slightly optimistic scenario as, again, condo construction in the Tokyo area is slowing down. It’ll be interesting to see how the company’s new Kyushu office performs in the coming years.

The bottom line

First Corporation is a newcomer to the construction industry, having only been around since 2011. The company brought back the long forgotten “Zochu” business model which was used in Japan during the economic miracle. In using the Zochu model, First Corporation has been able to deliver above-industry margins. Overall, the company is in good health, but with some concerns over future business performance due to condo construction slowing down. At 775 yen per share, the company trades at 2.5x EV/EBIT with a market cap of 10,353 million yen ($93.5 million USD). Investors can expect a three year investment CAGR of 10%, inclusive of dividends, if the company performs in line with 2018.


Kenkyo Investing
Kenkyo Investing

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