Thinking Points

  • Sanko Metal Industrial (TSE: 1972) is Japan’s leading large-scale roofing company, taking on projects such as roofing for sports stadiums, airports, and factories.
  • The company’s business performance is generally in line with the broader construction industry, with some fluctuations in performance.
  • After reaching a high in 2018, revenue performance has declined to historically normalized levels in 2019 although the construction industry remains strong.
  • At 2,411 yen per share, Sanko Metal Industrial trades at 1.1x EV/EBIT with a market capitalization of 9,567 million yen ($88.3 million USD).
  • Investors can expect an investment CAGR of between 9.9% and 18.9%, inclusive of dividends, over a three year period.

Introduction

Sanko Metal Industrial (TSE: 1972) is a roofing company specializing in large scale roofs used in sports complexes, airports, factories, and a variety of other applications. The company operates through two segments, but provides a more detailed revenue breakdown in its annual filings:

Source: Company filings

After Sanko Metal’s share price traded at 4,300 yen in February 2018, prices have declined down to today’s 2,400 yen level amid a general expectation of a weaker construction industry after the 2020 Tokyo Olympics. Despite weak expectations, however, Sanko Metal’s amount of orders carried over from fiscal 2019 remain strong compared to historically normal levels.

The business & environment

Sanko Metal Industrial was founded in 1949 in Yamaguchi Prefecture, a remote area of Japan. Since then, it has moved its headquarters to Tokyo (1961). From the very beginning, the company manufactured sheet metal for roofing. Although Sanko Metal does not hold any current patents, it developed a variety of roof construction methods since its founding.

According to Nikkei’s Sanko Metal company page (Japanese), the company is the biggest large-scale roofing company in Japan. Its project portfolio includes professional sports stadiums like Sapporo Dome, exhibition centers like Tokyo Big Sight, and airports like Kansai International Airport.

Source: Company page

Various types of roofing projects have historically accounted for 85+% of company revenues. Aside from roofing, Sanko Metal sells construction materials, paint, and power.

Source: Company filings

Revenues are project-based and largely dependent on a healthy construction industry. After the industry went through a two decade decline, it started improving in 2011. Sanko Metal’s revenues loosely follows the industry:

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

Sanko Metal purchases much of its materials from Nippon Steel (TSE: 5401), which is also the leading shareholder of Sanko Metal.

Aside from a short interview with Japan Metal Daily in 2017 (Japanese), the company’s management team mostly remains out of the spotlight. While much of the interview covered early 2017 business performance, CEO Hiroyuki Migita provided a couple of useful insights regarding Sanko Metal’s focus.

With the construction industry facing a severe labor shortage, Sanko Metal is focused on developing machines that increase labor productivity. One example mentioned in the interview was a seam welding machine for stainless steel sheets used in roofing, which would increase productivity at the construction site.

As an alternative approach to the productivity problem, the company is increasingly focusing on ready-made products. An example of this is Sanko Roof Lock, a metal roofing system wherein parts are joined together by design, without the need of bolting them together.

In recent years, order levels have come in strong, reaching a high in 2018. 2019 orders declined closer to normalized levels:

Source: Company filings

For fiscal 2020, the company is expecting 35,700 million yen ($329 million USD, -1.1% YoY) in revenues and 2,040 million yen ($18.8 million USD, -29.2% YoY) in operating income. While the company is expecting a continued strong construction investment environment, it is also expecting labor and material costs, as well as competitive pressures, to increase.

Shareholders

As of Q4 2019 (ending March 31st, 2019), Sanko Metal Industrial had 3,960,000 shares issued and 103,967 shares in treasury, putting outstanding shares at 3,856,033.

Here are the major shareholders:

Source: Company filings & Nikkei

Nippon Steel (TSE: 5401) effectively owns a 39% stake in Sanko Metal Industrial as it directly owns Nippon Steel Nisshin and indirectly owns Nihon Teppan.

The company does not offer equity compensation plans to the management team.

Financials & Valuation

  • Sanko Metal Industrial is Japan’s biggest large-scale roofing company, taking on projects such as roofing for sports stadiums, airports, factories, and a variety of other applications.
  • The company’s business performance is generally in line with the broader construction industry, with some fluctuations in performance.
  • After reaching a high in 2018, revenue performance has declined to historically normalized levels in 2019 although the construction industry remains strong.
  • At 2,411 yen per share, Sanko Metal Industrial trades at 1.1x EV/EBIT with a market capitalization of 9,567 million yen ($88.3 million USD).
  • Investors can expect an investment CAGR of between 9.9% and 18.9%, inclusive of dividends, over a three year period.

Sanko Metal Industrial is Japan’s leading large-scale roofing company, taking on projects ranging from airports to sports stadiums, factories, train stations, and more. The company is backed by Japan’s largest steel maker, Nippon Steel, which owns 39% of the Sanko Metal.

Roofing projects have historically accounted for 85+% of company revenues, with construction material sales consistently generating around 10% of annual revenues. Sanko Metal’s business performance is generally aligned with the health of the broader construction industry, with some fluctuation.

In recent years, the company has generated historically stronger levels of business performance, with operating margins exceeding 7%:

Source: Company filings

With weakening orders in 2019 and a general consensus of a slower construction industry after 2020, Sanko Metal share prices have declined from a high of 4,300 yen per share in February 2018 down to 2,400 yen per share level today.

At 2,411 yen per share Sanko Metal Industrial trades at 1.1x EV/EBIT with a market capitalization of 9,567 million yen ($88.3 million USD). With no real share cross-holdings, there aren’t any notable adjustments that need to be made. Additionally, Sanko Metal took advantage of a temporary law allowing the revaluation of land in 2002. Hence, the book value of its land holdings are roughly in line with current market prices.

When assessing fair value for Sanko Metal, it’s important to keep in mind that the company has enjoyed unusually strong operating margins over the last several years. On a more normalized basis, including business performance prior to the global financial crisis, the company generated an average of 1,300 million yen ($12 million USD) per year. Using historical average operating income, the company trades at 2.4x EV/EBIT.

Here, we will layout two scenarios: one where Sanko Metal delivers performance in line with guidance and another where business performance reverts back to historically normal levels.

If Sanko Metal’s performance is in line with guidance and we assume a fair value EV/EBIT of 3x, investors can expect an investment CAGR of 18.9%, inclusive of dividends, over a three year period.

On the other hand, if the company’s performance reverts back to historical averages, investors can expect an investment CAGR of 9.9%, inclusive of dividends, over a three year period.

There are two key risk factors for investors to consider when determining fair value for Sanko Metal. One is a decline in the construction industry and the other is behavioral considerations for other investors. Even if Sanko Metal maintained strong performance going forward, the consensus is that the construction industry will slow down in the near future. Unless the company considerably outperforms expectations, it’s difficult to imagine a case where share prices appreciate meaningfully.

With that in mind, investors can expect an investment CAGR of between 9.9% and 18.9%, inclusive of dividends, over the next three years.

The bottom line

Sanko Metal Industrial is a leading large-scale roofing company taking on projects like sports stadiums, airports, and factories. The company is backed by its leading shareholder Nippon Steel, the largest steelmaker in Japan. Recent business performance has been unusually strong and it’s likely that this will revert to historically normal levels. With this in mind, investors can expect an investment CAGR of between 9.9% and 18.9%, inclusive of dividends, over a three year period.


Kenkyo Investing
Kenkyo Investing

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