Thinking Points

  • Japan Process Development (TSE: 9651) mainly develops controls systems and software for industries that require non-stop system operations. Examples include thermal power plants, automotive controls, and train systems.
  • With a business relationship extending over 40 years, JPD is closely tied to the Hitachi Group (TSE: 6501), which accounted for 41.0% of company revenues in 2019.
  • Going forward, JPD is focused on developing its Advanced Driver Assistance Systems and IoT offerings for construction machinery and medical equipment into core businesses.
  • At 740 yen per share, Japan Process Development trades at an adjusted EV/EBIT of 0.7x with a market capitalization of 7,281 million yen ($67.8 million USD).
  • Investors can expect an investment CAGR of between 5.8% and 9.7%, inclusive of dividends, over the next three years.

Introduction

Japan Process Development (JPD, TSE: 9651) is mainly engaged in system and software development spanning a wide variety of industries. The company operates through six segments that are broadly categorized by industry:

Source: Kenkyo Investing, based on company data

Since 1977, about a decade after its founding, JPD has maintained a close business relationship with the Hitachi Group (TSE: 6501), which accounted for 41% of overall revenues in 2019. Hitachi Automotive Systems has increasingly accounted for more revenues, and JPD’s focal area for the medium term is on the continuing development of Advanced Driver Assistance Systems.

The business & environment

Japan Process Development was founded in 1967 to offer engineering, system development, and consulting services to the processing industry. Unlike traditional manufacturing operations (i.e., discrete manufacturing), where units of materials and components are assembled, process manufacturing involves continuous production (i.e., chemical plant). 

Specialized in process manufacturing, JPD has worked on controls and automation systems starting in the 1970s, before it became popular or well understood. In 1973, the company developed a control system for steel manufacturing plants. 

With process manufacturing requiring greater accuracy with lower tolerance for failures, the company naturally applied its process manufacturing system development capabilities to areas like nuclear power plants, communication controls, weather and earthquake observation systems, defense systems, infrastructure systems, and more.

Over 50 years after its founding, JPD remains focused on areas with low failure tolerance, like embedded systems, automotive systems, and infrastructure systems. Since 2011, the company has operated through six segments:

Source: Kenkyo Investing, based on company data

Control Systems

The Control Systems segment mainly consists of developing controls, monitoring, and simulation systems for the energy industry. This includes automatic control systems that turn on/off thermal power plants and control power production volumes. Secondarily, this segment also develops operations control systems for train networks. 

Transport Systems

The Transport Systems segment primarily covers two things: automotive control systems and automotive information systems. The company develops steering, engine, and transmission control systems. More recently, with the emergence of electric vehicles, the JPD has rapidly transitioned from developing hydraulic controls to electronic controls.

Specialized Information Systems

The Specialized Information Systems segment mainly offers satellite image processing systems for the aerospace and defence industries. The technology is also applied for identifying flood prone areas, disaster relief activities, and building risk management systems.

Embedded Systems

The Embedded Systems segment develops embedded middleware for everything from smart home appliances and digital copy machines to solid state drives and semiconductor memory devices. Demand for embedded systems has grown recently with the Internet of Things (IoT) movement.

Industrial and Public Information Systems

The Industrial and Public Information Systems segment develops public infrastructure systems like electronic toll collection (ETC) systems, train ticket machines, software services for the medical industry, and more. 

IT Services

The IT Services segment designs and builds system development environments, operates and maintains systems, and tests software and systems. A major part of the segment involves testing embedded software for products like smartphones and smart home appliances.

The common theme across all of JPD’s business segments is that continuous system operations is a requirement. According to the medium-term management plan, JPD’s focal point is on building Advanced Driver Assistance Systems and IoT business  for construction machinery and medical equipment into its core businesses.

In assessing JPD’s business performance, it’s important to keep in mind the Hitachi Group’s performance. Companies are required to report customers that account for more than 10% of total revenues. Hitachi has been on the list for over a decade with Hitachi Automotive Systems increasingly accounting for a greater portion of JPD’s business since 2012. Toshiba was previously a key customer for JPD until after the accounting scandal surfaced.

Source: Kenkyo Investing, based on company data

Historically, the company has maintained respectable operating margins, ranging between 4 and 9 percent over the last decade or so.

Source: Kenkyo Investing, based on company data

For fiscal 2020, Japan Process Development is expecting revenues of 7,620 million yen ($71 million USD, +5.6% YoY) and operating profits of 635 million yen ($5.9 million USD, +3.2% YoY). If achieved, this will be record-high business performance for JPD. 

Shareholders

As of Q4 2019 (ending May 31, 2019), Japan Process Development had 10,645,020 shares issued and 805,287 shares in treasury, putting outstanding shares at 9,839,733.

Here are the major shareholders:

Source: Kenkyo Investing, based on company data and Nikkei

The Obu family is the founding family of Japan Process Development. Hitoshi Obu is the current board chairman for JPD. 

JPD has periodically made meaningful share repurchases (2010, 2015, 2019) while regularly keeping a dividend payout ratio of above 50%. 

Financials & Valuation

  • Japan Process Development mainly develops controls systems and software for industries that require non-stop system operations. Examples include thermal power plants, automotive controls, and train systems.
  • With a business relationship extending over 40 years, JPD is closely tied to the Hitachi Group, which accounted for 41.0% of company revenues in 2019.
  • Going forward, JPD is focused on developing its Advanced Driver Assistance Systems and IoT offerings for construction machinery and medical equipment into core businesses.
  • At 740 yen per share, Japan Process Development trades at an adjusted EV/EBIT of 0.7x with a market capitalization of 7,281 million yen ($67.8 million USD).
  • Investors can expect an investment CAGR of between 5.8% and 9.7%, inclusive of dividends, over the next three years.

Originally focused on serving the process manufacturing industry, Japan Process Development mainly develops controls systems and software that require non-stop operations. Its systems are used in automotive controls, power plant operations, smart home appliances, train systems, and more. 

The Hitachi Group has remained an important customer since JPD’s early days. More recently, the company’s reliance on the Hitachi Group is increasing, which accounted for 41.0% of total revenues in 2019. Investors interested in JPD are strongly advised to also follow developments in the Hitachi Group as well.

JPD has periodically made meaningful share repurchases (2010, 2015, 2019) while regularly keeping a dividend payout ratio of above 50%. Meanwhile, it’s operating margins remain stable but low for an established software development company, generally ranging between 4 to 9 percent. Interestingly, despite its stable operating margins and regular shareholder returns, the company still maintains a bloated balance sheet with an equity-to-asset ratio of 0.83 and ROE generally below 6 percent.

At 740 yen per share Japan Process Development trades at an EV/EBIT of 7.3x with a market capitalization of 7,281 million yen ($67.8 million USD). Adjusted for long-term investment securities, the company trades at 0.7x EV/EBIT.

The biggest factor affecting JPD’s business performance is the Hitachi Group’s health and tolerance level for cyclicality. Although Hitachi booked losses through the 2008-2010 global financial crisis, JPD managed to get by profitably, though with deteriorating operating performance. In recent years, however, JPD has booked record high business performance. In calculating a fair valuation range for the company, it’s important to keep normalized performance levels in mind. 

Assuming a fair value adjusted EV/EBIT of 3x with normalized performance as the low end and continued current performance levels at the high end of the valuation range, investors can expect an investment CAGR of between 5.8% and 9.7%, inclusive of dividends, over the next three years.

The bottom line

Since its founding, Japan Process Development focused on developing control systems for the process manufacturing industry. The company extended its expertise in continuous system operations to different verticals, including automotive control systems, train systems, power plant operation systems, and more. With a close business relationship with the Hitachi Group, investors interested in JPD are advised to also track Hitachi’s performance. At 740 yen per share, investors can expect to gain an investment CAGR of between 5.8% and 9.7%, 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.