Thinking Points

  • Techno Ryowa (TSE: 1965) is a construction company mainly engaged in the design and construction of air conditioning and sanitation facilities.
  • The company started out by performing installation work for Mitsubishi Heavy Industry’s refrigeration equipment, then expanded its business to include air conditioning systems, sanitation facilities, and electrical works.
  • Its recent focus is on expanding the company’s overseas presence, particularly in Southeast Asia. However, the company has made attempts in the past with little success.
  • At 768 yen per share, Techno Ryowa trades at an adjusted negative EV with a market capitalization of 17,012 million yen ($157 million USD).
  • Investors can expect an investment CAGR of between 7.9% and 15.8%, inclusive of dividends, over a 3 to 8 year period.

Introduction

Techno Ryowa (TSE: 1965) is a construction company mainly engaged in the design and construction of air conditioning and sanitation facilities. Although the company operates through a single segment, it breaks down revenues into four different categories:

Source: Kenkyo Investing, based on company data

The company is taking a balanced approach to operating its project portfolio, mainly focusing on industrial facilities in the medical and food industries. Additionally, it plans to expand its business in Southeast Asia, targeting international revenues to reach 5% of total revenues by 2021.

The business & environment

Techno Ryowa was founded in 1949 in Nagoya by Hachiro Chikashige. The company started out by performing refrigeration work specializing in the installation of Mitsubishi Heavy Industry’s refrigeration products.

Five years after its founding in 1954, Techno Ryowa started engaging in the design and construction of air conditioning facilities, the company’s main business today. The company continued to progress into new and related business areas, starting its industrial specialty air conditioning system business in 1960.

After moving its headquarters to Tokyo in 1966, Techno Ryowa rapidly expanded its sales network across most major metropolitan areas in Japan. The company then started focusing on expanding its overseas operations in the 1980s and on, opening offices in Singapore (later moved to Indonesia) and the Philippines.

Neither overseas operations seemed to gain any traction, with the company effectively exiting both countries in the 1990s. More recently, however, Techno Ryowa has made a second attempt in Indonesia, setting up a new subsidiary in the country in 2016.

Today, the company mainly engages in construction and design work on air conditioning and sanitation facilities in Japan. This includes everything from precision air conditioning for clean rooms to water treatment systems for buildings.

Much of Techno Ryowa’s work comes from the private sector, which accounted for 84.8% of revenues in 2019. With the exception of 2010 and 2011, over 80% of the company’s revenues were generated in the private sector over the past decade.

While in its medium term plan, the company aims to raise overseas revenues to account for 5% or more of total revenues by 2021, Techno Ryowa is still heavily dependent on its Japan revenues, which accounted for 98% of total revenues in fiscal 2019.

That said, the company’s Japan business has been thriving over the last several years:

Source: Kenkyo Investing, based on company data

Operating profits have also been growing in recent years:

Source: Kenkyo Investing, based on company data

The severe decline in operating profits in 2012 was largely attributable to an increasingly competitive ordering environment combined with the 2011 Tohoku Earthquake and its subsequent reconstruction efforts creating a shortage in labor, resulting in increased labor costs and unprofitable projects.

For fiscal 2020, Techno Ryowa expects revenues of 63,000 million yen ($582 million USD, -6.5% YoY) and operating profits of 2,820 million yen ($26.1 million USD, -37.6% YoY). As of Q1 2020 (ending June 30, 2019), the company booked 13,421 million yen ($124 million USD, +11.1% YoY) in revenues and 395 million yen ($3.7 million USD, +8.1x YoY). 

Shareholders

As of Q1 2020 (ending June 30, 2019), Techno Ryowa had 22,888,604 shares issued and 737,590 shares in treasury, putting outstanding shares at 22,151,014.

Here are the major shareholders:

Source: Kenkyo Investing, based on company and Nikkei data

In Techno Ryowa’s case, the founding family (Chikashige family) has no control over the company. Judging by the family names of the management team, it appears that none of the founding family members are involved in the company.

Interestingly, after no share repurchases in the last decade, Techno Ryowa conducted a large scale buyback in fiscal 2019. In the first transaction, which took place in November 2018, the company repurchased 371,800 shares for a total of 332 million yen ($3.1 million USD), or 892 yen per share. In the second transaction, which took place in February 2019, the company repurchased 352,100 shares for a total of 317 million yen ($2.9 million USD), or 901 yen per share. Combined, the repurchases accounted for ~3.2% of outstanding shares.

There are no unexercised stock options or management equity compensation plans.

Financials & Valuation

  • Techno Ryowa is a construction company mainly engaged in the design and construction of air conditioning and sanitation facilities.
  • The company started out by performing installation work for Mitsubishi Heavy Industry’s refrigeration equipment, then expanded its business to include air conditioning systems, sanitation facilities, and electrical works.
  • Its recent focus is on expanding the company’s overseas presence, particularly in Southeast Asia. However, the company has made attempts in the past with little success.
  • At 768 yen per share, Techno Ryowa trades at an adjusted negative EV with a market capitalization of 17,012 million yen ($157 million USD).
  • Investors can expect an investment CAGR of between 7.9% and 15.8%, inclusive of dividends, over a 3 to 8 year period.

Techno Ryowa is an established construction company mainly engaged in the design and construction of air conditioning and sanitation facilities. Additionally, the company secondarily engages in electrical work. 

What’s particularly interesting about Techno Ryowa’s business performance is that it weathered through the 2008-2010 global financial crisis without any notable deterioration. In its filings, the company comments that it makes efforts to build its business to minimize the impact of economic factors, although the company’s focus is primarily on industrial facilities related work.

The operating loss posted in 2012 was mainly attributable to external factors outside of Techno Ryowa’s control, namely the rise in labor costs as a result of the 2011 Tohoku Earthquake and the subsequent reconstruction efforts. With damaging earthquakes being a periodic factor, the company may post similar losses when similar natural disasters occur.

At 768 yen per share, Techno Ryowa trades at an EV/EBIT of 1.2x  with a market capitalization of 17,012 million yen ($157 million USD). Adjusted for long-term investment security holdings, however, the company trades at negative EV. The company also trades at 87.4% NCAV, or 62.5% NCAV when adjusted for long-term investment security holdings. Techno Ryowa also holds land assets like many other established construction companies, but the book value of its land is likely more in line with current market prices as it was revalued in 2002.

To be sure, the unadjusted EV/EBIT of 1.2x is partially a result of recently high profits. On a 10-year normalized basis, the company’s EV/EBIT multiple (before adjusting for investment security holdings) would be at 2.8x.

If we assume Techno Ryowa’s operating profits return to 10-year normalized levels and estimate fair valuation at about 3x EV/EBIT, investors can expect an investment CAGR of about 15.8%, inclusive of dividends, over the next three years. 

If we assume similar normalized business performance and a fair value of between 100% and 120% adjusted NCAV for the company with a longer investment period, investors can expect an investment CAGR of between 7.9% and 15.7%, inclusive of dividends, over 5 to 8 years.

The bottom line

Techno Ryowa is a healthy and established construction company mainly engaged in the design and construction of air conditioning and sanitation facilities. Aside from external factors like higher labor costs due to natural disasters resulting in operating losses, the company has remained consistently profitable. Although the company has recently posted supernormal profits, it is trading cheaply even on a normalized basis. Investors can expect an investment CAGR of between 7.9% and 15.8% over a 3 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.