Thinking Points

  • NJS (TSE: 2325) is a well established construction consulting firm specializing in water supply and drainage design, engineering, and maintenance management.
  • With Japan’s aging water facility infrastructure and move towards privatization, NJS is among a few companies well positioned to benefit from macro trends.
  • That said, NJS isn’t without problems, with several employees and directors being arrested in early 2016 for interference of competitive bidding on public works projects.
  • At 1,504 yen per share, NJS trades at an adjusted EV/EBIT of -0.2 with a market cap of 14,661 million yen ($132 million USD).
  • Investors can expect an investment CAGR of between 7.9% and 19.5% over the next three years, inclusive of dividends.

Introduction

NJS (TSE: 2325) is a construction consulting firm specializing in water supply and drainage design, engineering, and maintenance management. The company mostly operates in Japan, but also generates 21% of its revenues overseas:

Source: Company filings


As Japan’s water supply infrastructure ages, NJS is increasingly focusing on maintenance management solutions. With over 15% of Japan’s water pipes outliving its 40-year useful life, macro trends are in favor of NJS. In February 2019, we covered Original Engineering Consultants (TSE: 4642), a competitor of NJS with similar offerings. Investors are encouraged to go back and read the OEC article as well.

The business & environment

NJS was founded in 1951 as a private school to develop water drainage experts. This pre-dates the Japanese government’s post-war founding of the Science & Technology Agency (now part of Ministry of Education, Culture, Sports, Science, and Technology) in 1956.

Shortly after founding in 1956, NJS was tasked with the design and engineering of water supply and drainage for Yahata Steel Works’ Tohata Plant (now part of Nippon Steel [TSE: 5401]). From there on, NJS supported steel production, the foundation of Japan’s post-war reconstruction and economic growth.

With the fast pace of growth, both in population and industry, came water pollution. Japan was in dire need of a reliable drainage system. Lead by the national government, drainage systems were implemented across Japan in the 1970s and 1980s. NJS took on work in its original specialty, expanding its sales office network nationally along the way.

Meanwhile, the company started looking for business overseas. In 1982, NJS setup an office in Manila, Philippines, where the Asian Development Bank is headquartered. The company continued on with its involvement in various development projects with the Japanese government, Asian Development Bank, World Bank,  and more, extending its reach to projects in over 90 countries.

In the 1990s, Japan started focusing on the maintenance of its water supply and drainage systems. NJS started modernizing, suggesting the digitization of processes to its customers. In the late 1990s, Japan passed a law allowing limited privatization of public works. In 1998, NJS setup subsidiary NJS E&M to manage, maintain, and operate water supplies, accommodating the updated laws.

From the 2000s and on, NJS has been focusing on maintenance and implementing modern technology and software to manage water supply and drainage assets. With Japan’s amendment to its Water Supply Act in December 2018, NJS is in a good position to accept work related to the privatization of Japan’s water supply. With that said, it’s important to keep in mind that privatization of water supply has generally ended with negative outcomes internationally.

NJS’ revenues have been distributed as follows:

Source: Company filings


Depending on the data source, operating performance is reported incorrectly. Here is the operating performance taken directly from company filings:

Source: Company filings


Japan’s water facility maintenance, after some decline through the late 2000s, has remained stable:

Source: Federation of Japan Water Industries (FJWI), Ministry of Health, Labour, and Welfare (MHLW)


It’s highly unlikely that this budget will be cut to a significant extent, primarily because Japan’s water supply infrastructure is in need of maintenance and replacement. The Japan Water Works Association (JWWA) estimated that 15.1% of Japan’s water pipes in use exceeded its 40-year useful lifespan as of 2016, with replacement rates below 1%.


Source: Ministry of Internal Affairs and Communications (Japanese) / Japan Water Works Association


For fiscal 2019, NJS is guiding 17,400 million yen ($157 million USD, -4.7% YoY) in revenues and 2,150 million yen ($19.4 million USD, -25.5% YoY) in operating income. This is in accordance to its revised medium term plan ending in 2020:

Source: Company filings


2018 revenues and operating income came in above original and revised projections, although 2019 projections were lowered.

It’s important to mention here that NJS isn’t without problems. In early 2016, several NJS employees and directors were arrested for competitive bidding interference on public works projects. No related news has emerged since this happened.

Shareholders

As of fiscal year end 2018 (ending December 31st, 2018), NJS had 10,048,000 shares issued and 300,241 shares in treasury, putting outstanding shares at 9,747,759.

Here are the major shareholders:

Source: Company filings & Nikkei


Nippon Hume (TSE: 5262) is Japan’s largest hume pipe manufacturer. The company is also a large maker of pile tubes and secondary concrete products.

There are no stock option plans for management.

Financials & Valuation

  • NJS is a well established construction consulting firm specializing in water supply and drainage design, engineering, and maintenance management.
  • With Japan’s aging water facility infrastructure and move towards privatization, NJS is among a few companies well positioned to benefit from macro trends.
  • That said, NJS isn’t without problems, with several employees and directors being arrested in early 2016 for interference of competitive bidding on public works projects.
  • At 1,504 yen per share, NJS trades at an adjusted EV/EBIT of -0.2 with a market cap of 14,661 million yen ($132 million USD).
  • Investors can expect an investment CAGR of between 7.9% and 19.5% over the next three years, inclusive of dividends.

Founded in 1951 as a private school training water drainage experts, NJS is an established specialty construction consulting firm with a rich history. More recently, the company is focusing on implementing modern technology and software to better track assets and manage water facility maintenance activities.

In the late 1990s, NJS setup a subsidiary NJS E&M, to manage, maintain, and operate water supplies. Interestingly, Japan passed an amendment to its Water Supply Act in December 2018, effectively nudging privatization. NJS is among a few companies well positioned to take advantage of this, although privatization movements in other countries have mostly ended in negative outcomes.

To be sure, NJS isn’t without problems, with several employees and directors arrested in early 2016 for interference of competitive bidding on public works projects. With that said, the company consistently generates a profit and has macro tailwinds.

NJS’ balance sheet mostly consists of cash, which accounts for 59.9% of all assets. The company carries no debt with an equity-to-asset ratio of 0.72. In addition to its operating business, NJS also has several rental properties listed on the balance sheet. The land for this is recorded on the balance sheet with a book value of 1,050 million yen ($9.5 million USD). Unfortunately, the exact address is unidentifiable from the filings or the company website, so it’s hard to determine whether book value reflects the current market price.

At 1,504 yen per share, NJS trades for 0.4x EV/EBIT with a market cap of 14,661 million yen ($132 million USD). Adjusted for investment securities and deposits, EV/EBIT is at -0.2x. This is quite low for a operationally healthy, asset rich company. Here, we will layout two scenarios for NJS’ valuation. In the first scenario, we will use 2016 business performance (lowest in ten years) and extrapolate 3 years out to assign valuation. In the second scenario, we’ll use NJS’ guidance to calculate valuation.

In the first scenario, we will assume operating income of 774 million yen ($7 million USD). Dividends will be reduced down to 10 yen per share, or roughly 20% of current payout. Over the course of three years, NJS will accumulate more cash. With a modest EV/EBIT ratio of 3x, investment CAGR would come in at 7.9% over three years.

For the second scenario, operating income will gradually increase to 2,200 million yen ($19.8 million USD) into 2020, and then continue at the same level into 2021. Dividends will carry on at the current 45 yen per share. With a modest EV/EBIT ratio of 3x, investment CAGR would come in at 19.5% over three years.

Overall, investors can expect to gain an investment CAGR of between 7.9% and 19.5% over three years, inclusive of dividends. It’s important to note here that NJS comes with elements that the market may get excited about, particularly with the discussion of privatization. Additionally, there is a good basis for continued strong business performance with Japan’s aging infrastructure.

The bottom line

NJS is a well established construction consulting firm specializing in water supply and drainage design, engineering, and maintenance. The company is operationally healthy and rich in assets, with macro trends in favor of continued strong business performance. At 1,504 yen per share, the company trades at an adjusted -0.2 EV/EBIT with a market cap of 14,661 million yen ($132 million USD). Investors can expect an investment CAGR of between 7.9% and 19.5%, inclusive of dividends, over the next three 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.