Thinking Points

  • Natoco (TSE: 4627) is primarily engaged in the manufacture of industrial coatings and secondarily engaged in the manufacture of fine chemicals and thinners.
  • The company’s history is one of slow but calculated growth with a focus on its area of expertise: coating and related chemical manufacturing.
  • With a comfortably net cash balance sheet and no debt for over a decade, Natoco is overcapitalized by western standards but offers considerable long-term stability.
  • At 1,007 yen per share, Natoco trades at an EV of negative 1,372 million yen (-$12.8 million USD) with a market capitalization of 7,596 million yen ($71.1 million USD).
  • Investors can expect an investment CAGR of between 7.5% and 16.4%, inclusive of dividends, over the next three years.

Introduction

Natoco (TSE: 4627) is a chemical manufacturer primarily engaged in the manufacture of industrial coatings and secondarily engaged in the manufacture of fine chemicals and thinners. The company operates through three segments: Coating, Fine Chemicals, and Thinner.

Source: Kenkyo Investing, based on company data

Over the past decade, the company focused on further developing its high value add product lineup and expanding overseas sales, primarily in Asia. More recently, the Asia-focus includes Southeast Asia with new subsidiary companies established in the Philippines (2014) and Thailand (2019). 

The business & environment

Natoco was founded in Nagoya in 1948 by Kikujiro Kasuya to manufacture and sell thinner and alcoholic varnishes. Eight years after its founding, the company shifted to manufacturing synthetic resin paints and lacquer paints – it’s core product lineup today. 

The company spent the next four decades (~1990s) building its domestic production capacity and sales network. By 1995, Natoco was operating one distribution center, one research lab, and three production facilities. Additionally, the company ventured into LCD polymer production, dedicating one of its three production facilities. 

After building a fourth factory (LCD polymer), Natoco made its first leap outside of Japan. In 2003, the company established a subsidiary Natoco Paint Chemical Industry (Qingdao) Co., Ltd. in China. Its overseas expansion remained rather quiet after this, with the operating business taking a hit following the 2008-2010 global financial crisis.

Natoco’s silence was short-lived, however, with the company opening a sales office in South Korea in 2011. This was followed by the establishment of Natoco Fine Chemical (Qingdao) Co., Ltd. in China in 2012, the acquisition of industrial coating manufacturer Toyokawa CMC in 2012, and the acquisition of local Nagoya partner Tomoe Corporation.

In 2014, Natoco entered the Southeast Asian market by establishing NATOCO PAINT PHILIPPINES Inc. In the same year, the company acquired industrial waste processing company IC Sangyo in Japan. Then in 2019, the company entered its second Southeast Asian market by establishing NATOCO PAINT(THAILAND)CO., LTD.

As of FY10/20, Natoco still primarily depends on its coating business, but has also established its much smaller but highly profitable fine chemical business as a second pillar.

Source: Kenkyo Investing, based on company data

The previous Other segment consisted of industrial waste collection and processing. In FY10/14, after the acquisition of Tomoe Corporation, Natoco reorganized its segments, creating the Thinner segment. The newly established segment combined Natoco’s existing thinner business (previously under Coating segment) with Tomoe Corporation’s thinner business and included the industrial waste collection and processing business.

According to company filings, the Coating business mainly caters to machine tool and construction material coatings while products in the Fine Chemical business are used for end markets such as smartphone accessories and automotive interior coatings. In other words, Natoco has some exposure to cyclical swings.

Source: Kenkyo Investing, based on company data

One interesting way to gauge Natoco’s business performance may be to look at its biggest customer’s performance. Nichiha Corporation (TSE: 7943), a company mainly manufacturing and selling construction materials (exterior) has accounted for roughly 20% of Natoco’s revenues over the last decade. 

Over the medium to long term, Natoco remains focused on developing high value add products and continuing its Asia-focused expansion. At its peak, the company’s overseas business accounted for 23.6% of overall revenues (FY10/13). In the years following, overseas revenues dropped to less than 10% of overall revenues, then  slowly picked back up to 13.9% of overall revenues in FY10/19.

For FY10/20, Natoco expects revenues of 17,800 million yen ($167 million USD, +0.6% YoY) and operating profit of 1,520 million yen ($14.2 million USD, -1.5% YoY). As of Q1 FY10/20, the company booked revenues of 4,088 million yen ($38.2 million USD, – 7.2% YoY) and operating profit of 298 million yen ($2.8 million USD, -34.1% YoY). Keep in mind, the company forecast has not adjusted forecasts for coronavirus related effects. 

Shareholders

As of Q1 FY10/20 (ending January 31, 2020), Natoco had 8,144,400 shares issued and 600,923 shares in treasury, putting outstanding shares at 7,543,477.

Here are the major shareholders:

Source: Kenkyo Investing, based on company data & Nikkei

Natoco remains significantly influenced by the founding Kasuya family. Tomoe Holdings is the Kasuya family fund. Collectively, the family controls over 35% of outstanding shares, with 4 of the 11 board members from the Kasuya family, including the CEO and the chairman.

The company doesn’t have a history of share repurchases other than in FY10/14, when it repurchased shares shortly after the share-based acquisition of Tomoe Corporation in 2013. As for dividends, Natoco maintains a vague dividend policy, but has historically maintained a dividend payout ratio of around 20 to 30%.

The company does not offer management equity compensation. 

Financials & Valuation

  • Natoco (TSE: 4627) is a chemical manufacturer primarily engaged in the manufacture of industrial coatings and secondarily engaged in the manufacture of fine chemicals and thinners.
  • The company’s history is one of slow but calculated growth with a focus on its area of expertise: coating and related chemical manufacturing.
  • With a comfortably net cash balance sheet and no debt for over a decade, Natoco is overcapitalized by western standards but offers considerable long-term stability.
  • At 1,007 yen per share, Natoco trades at an EV of negative 1,372 million yen (-$12.8 million USD) with a market capitalization of 7,596 million yen ($71.1 million USD).
  • Investors can expect an investment CAGR of between 7.5% and 16.4%, inclusive of dividends, over the next three years.

Natoco maintains a conservative business strategy with a primary focus on incremental improvement and growth in its area of expertise. Its acquisition history consists of partner businesses or businesses in the same industry. Moreover, it wasn’t until the last several years that the company doubled down on its overseas expansion efforts.

Its conservatism, however, doesn’t make it immune to cyclical swings. While the company managed to profitably make it through the 2008-2010 global financial crisis at the operating level (booked net losses), revenues were down 22.0% and operating profits were down 64.0% YoY in FY10/09. Given Natoco’s exposure to construction, automotive, and industrial equipment industries, it’s highly likely that the coronavirus situation poses a major threat to near term operating performance.

To be sure, the company is more than prepared for a drawn out downturn. Its balance sheet is net cash positive with no debt and an equity to asset ratio of 0.79. Without a doubt, Natoco maintains a historically overcapitalized balance sheet. Given its consistent history of essentially no share repurchases and a dividend payout ratio generally in the 20 to 30% range, interested investors should expect no different from management going forward unless activist investors get involved or some other unusual event occurs.

At 1,007 yen per share, Natoco trades at an EV of negative 959 million yen (-$9.0 million USD) with a market capitalization of 7,596 million yen ($71.1 million USD). Adjusted for long-term investment security holdings, the company trades at an EV of negative 1,372 million yen (-$12.8 million USD).

Natoco’s share price traded at the 1,400 yen level as recently as February 2020, but has since collapsed to the current 1,000 yen level, presumably due to concerns over the impact of coronavirus. On an EV basis, Natoco is already trading in the range of its post global crisis lows in FY10/12. While this certainly does not mean prices cannot decline further, it may serve as a good entry point for medium to long-term investors that are comfortable with near term operating losses and its consequences on share price.

With the assumption of operating profits falling to 0 in FY10/20, a recovery to the 1,200 million yen ($11.2 million USD) level in the subsequent two years, and a share price recovery to 0.0x EV, investors can expect an investment CAGR of about 7.5%, inclusive of dividends, over the next three years.

With a more optimistic assumption of operating profits at 2008-2010 global financial crisis levels, a recovery to the 1,200 million yen ($11.2 million USD) level in the subsequent two years, and a share price recovery to 2.0x EV, investors can expect an investment CAGR of about 16.4%, inclusive of dividends, over the next three years.

In other words, investors can expect an investment CAGR of between 7.5% and 16.4%, inclusive of dividends, over the next three years.

The bottom line

Natoco is a conservatively managed chemical manufacturer that only recently started doubling down on its efforts for overseas expansion. While the company is exposed to cyclical swings and is highly likely to be negatively impacted by the coronavirus situation, it is financially prepared to weather through. At 1,007 yen per share, investors can expect an investment CAGR of between 7.5% and 16.4%, inclusive of dividends, over the next three years.