Thinking Points

  • Freund Corporation (TSE: 6312) is among three key niche manufacturers of pharmaceutical machinery, and the only one that also sells chemicals used in the pharmaceutical manufacturing process.
  • The company maintains an asset-light fabless operations for its Machinery segment while producing some of its own chemicals.
  • More recently, the Chemical segment has delivered strong performance while the Machinery segment performance weakened with lower domestic demand and a low-profit large scale order in the US.
  • At 796 yen per share, Freund Corporation trades at 148% of adjusted NCAV with a market capitalization of 13,329 million yen ($123 million USD).
  • Investors can expect an investment CAGR of between 6.7% and 14%, inclusive of dividends, over the next 5 to 8 years.

Introduction

Freund Corporation (TSE: 6312) primarily manufactures and sells pharmaceutical machinery and chemicals, with a particular strength in pharmaceutical film coating machines. The company operates through two segments: Machinery and Chemicals.

Source: Company filings

The company operates a razor and blade business model, selling pharmaceutical machinery, then supplying chemicals used in the machinery. Chemicals include functional excipients (inactive ingredients for drugs), food preservatives, and dietary supplements.

The business & environment

Freund Corporation was founded in 1964 when the company developed and sold the world’s first pharmaceutical film coating machine. The inspiration came about when founder Yasutoyo Fusejima discovered that drug tablet coatings were applied by hand in the pharmaceutical manufacturing process.

Together with a friend, Yasutoyo developed the pharmaceutical film coating machine to replace the labor intensive coating process. The machine quickly became a hit, resulting in the company turning a  profit from its first year in operation.

Just about a decade after its founding, Freund Corporation started manufacturing and selling its first pharmaceutical additives. Yasutoyo’s uncle, who was the CEO of a copy machine manufacturer now owned by Canon (TSE: 7751), gave him the idea for what is now commonly referred to as the razor and blade business model.

From then on, the company expanded its lineup of pharmaceutical machinery offerings to increasingly cover a larger portion of the pharmaceutical manufacturing process, which can be summarized as follows:

Source: Various

The company provides machinery for processes highlighted in orange above.

Source: Company presentation

Today, the company is one of 3 major global players in the industry, and the only one selling both machines and chemicals. The other two key players are Glatt (private, Germany) and GEA (ETR: G1A, Germany).

As for competition in the chemicals, or more specifically pharmaceutical excipients, Freund comes in behind major chemical companies like Shinetsu Chemicals (TSE: 4063), Asahikasei (TSE: 3407) and Sanwa Chemicals (subsidiary of Suzuken, TSE: 9987).

Separate from machinery and chemicals, Freund Corporation applies its pharmaceutical machinery technology to other areas like lithium ion battery electrode covering machines. This still accounts for a small portion of overall sales.

What’s particularly interesting about Freund Corporation’s business is that Chemical segment operating margins has grown stronger, tripling over the last 5 years. It’s important to note here that Freund Corporation’s machinery are manufactured by partnered manufacturers, while the company produces some of its own chemicals.

Source: Company filings

The operating margins in the above chart are not adjusted for company-wide expenses. The company attributes the decline in machinery margins to a normalization of domestic demand after a period of push for increased generic drug usage by the Japanese government, a low-profit large order with its US subsidiary, and a rapid slowdown in industrial machinery orders. Meanwhile, the Chemical segment fared well, particularly with healthy demand for pharmaceutical additives by generic drug manufacturers.

Source: Company filings

Still, with the Chemical segment overtaking the Machinery segment in terms of operating profits, Freund Corporation successfully marked its 55th consecutive year of profits.

For fiscal 2020, the company expects revenues of 17,500 million yen ($161 million USD, -4.9% YoY) and operating income of 1,000 million yen ($9.2 million USD, -18.2% YoY). Interestingly, the company is expecting a 11.1% decline in Machinery segment revenues and a 7.6% increase in Chemical segment revenues in fiscal 2020.

Shareholders

As of Q4 2019 (ending February 28th, 2019), Freund Corporation had 18,400,000 shares issued and 1,655,480 shares in treasury, putting outstanding shares at 16,744,520.

Here are the major shareholders:

Source: Company filings & Nikkei

Collectively, the founding Fusejima family owns 19.3% of outstanding shares. Okawara Manufacturing is one of Freund Corporation’s partnered machine manufacturers.

The company has no unexercised stock options outstanding and offers no equity compensation plans to the management team.

In April 2018, the company repurchased 500,000 shares for 572 million yen, or 1,144 yen per share. This was the first meaningful repurchase in over a decade.

Financials & Valuation

  • Freund Corporation is one of three key niche manufacturers of pharmaceutical machinery, and the only one that also sells chemicals used in the pharmaceutical manufacturing process.
  • The company maintains a fabless operations for its Machinery segment while producing some of its own chemicals.
  • More recently, the Chemical segment has delivered strong performance while the Machinery segment performance weakened with lower domestic demand and a low-profit large scale order in the US.
  • At 796 yen per share, Freund Corporation trades at 148% of adjusted NCAV with a market capitalization of 13,329 million yen ($123 million USD).
  • Investors can expect an investment CAGR of between 6.7% and 14%, inclusive of dividends, over the next 5 to 8 years.

Freund Corporation is one of 3 key companies in the world that manufactures pharmaceutical machinery, and is the only one that also sells chemicals used with its machines. Since its founding in 1964, the company has generated profits for 55 consecutive years.

After getting its start by developing the world’s first pharmaceutical film coating machine, Freund Corporation expanded its lineup of pharmaceutical machinery to address a wide range of the pharmaceutical manufacturing process, like crushing, screening, granulation, and printing.

The company was able to do this by outsourcing the manufacturing process of its machines to partnered manufacturers. Meanwhile, the company internally manufactures some of its chemicals products. This has paid off, with operating margins for the Chemical segment improving three-fold, compared to 5 years ago.

Freund Corporation maintains a healthy net cash balance sheet with no debt and an equity to asset ratio of 0.76. Additionally, the book value of its key land holdings are in line with current market prices.

At 796 yen per share, the company trades at an unadjusted 153% of NCAV with a market capitalization of 13,329 million yen ($123 million USD). Adjusted for investment security holdings, the company trades for 148% of NCAV.

Given Freund Corporation’s niche industry focus and track record for consistent profitability, it’s fair to say the company runs a high quality operating business. With this in mind, a fair value of 200% ~ 250% is appropriate over a 5 to 8 year time frame.

Assuming a fair value of 250% adjusted NCAV and Freund Corporation performing in line with 2020 guidance, investors can expect an investment CAGR of between 9.5% and 14%, inclusive of dividends, over a 5 to 8 year period.

With a fair value of 200% adjusted NCAV, investors can expect an investment CAGR of between 6.7% and 9.2%, inclusive of dividends, over a 5 to 8 year period.

Source: Kenkyo Investing estimates

As a side note, 2020 guidance is weaker than historical average performance.

The bottom line

Freund Corporation is one of 3 key niche manufacturers of pharmaceutical machinery, and the only one selling chemicals used in the pharmaceutical manufacturing process. Additionally, the company maintains a fabless operation for its machineries, outsourcing the manufacturing process to partnered manufacturers. With a niche focus and a track record for consistent profitability, the company operates a high quality business. Investors can expect an investment CAGR of between 6.7% and 14%, inclusive of dividends, over a 5 to 8 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.