Thinking Points

  • Taiyo Kisokogyo (TSE: 1758) is a small civil engineering contracting company that is moving toward prime contracts to establish itself as a mid-tier contractor.
  • The company generally maintains healthy operating margins compared to some of its peers of similar size according to reports published by the Japanese government.
  • Moreover, Taiyo Kisokogyo is branching out from its mainstay infrastructure related business, recently extending its services to include renovations and apartment construction work.
  • At 5,430 yen per share, Taiyo Kisokogyo trades at a negative EV with a market capitalization of 3,614 million yen ($33.0 million USD).
  • Investors can expect an investment CAGR of between 11.6% and 15.8%, inclusive of dividends, over three years.

Introduction

Taiyo Kisokogyo (TSE: 1758) is a civil engineering company based in Nagoya. The company operates through four segments: Special Civil Engineering, Residential related, Machinery, and Reusable Energy.

Source: Kenkyo Investing, based on company filings

In recent years, Taiyo Kisokogyo has increasingly focused on obtaining contracts as the prime contractor for the Special Civil Engineering business while developing its new construction arm for the Residential related business. 

The business & environment

Taiyo Kisokogyo was founded in Nagoya in 1958 as a sole proprietorship by Mitsuru Toyozumi, and was incorporated in 1965 as a civil engineering contractor. Similar to many other Japanese construction companies, the company does not have a meaningful amount of public coverage. Interestingly, however, Taiyo Kisokogyo has had an equipment and machinery arm since the 1960s.

It wasn’t until 1973 that the company opened an office outside of its home prefecture of Aichi. In fact, the company opened two offices in neighboring prefectures – Shizuoka and Mie prefectures – at the same time. Over the course of several decades, Taiyo Kisokogyo opened offices in Kanto (Tokyo area), Kinki (Osaka area), Kyushu (southwestern Japan), and Tohoku (northern Japan) regions. 

The company’s projects remain heavily focused on its home turn of central Japan (Nagoya area), however, with nearly 40% of revenues generated in the region in FY01/19. Its coverage area isn’t quite nationwide, but with respectable reach for a smaller contractor, covering most major areas except for Hokkaido (northernmost Japan).

Until recently, Taiyo Kisokogyo was almost purely focused on infrastructure related works, both for its Special Civil Engineering and Residential-related businesses. More recently, the company started a residential construction division, which has taken on everything from renovation work to apartment building construction. 

In the Special Civil Engineering business, the company’s key strengths are in continuous underground wall, underground obstacle removal, ground improvement, and pipeline construction works. Additionally, the company offers urban development related work such as environmental protection, seismic reinforcement, and liquefaction prevention works.

Although the company does not show any single customer accounting for more than 10% of annual revenues in its filings, it did note that Sekisui House (TSE: 1928), one of the leading residential developers in Japan, and its group companies accounted for about 35% of annual revenues in FY01/20. Separately, Taiyo Kisokogyo generated another third of annual revenues from public works projects in FY01/20.

Source: Kenkyo Investing, based on company data

With around 10,000 million yen ($91.7 million USD) in annual revenues, Taiyo Kisokogyo is still a small player in the industry. However, with offices in most major regions, the company is working to grow out of lower-tier contractor work. Since FY01/19, the company started specifically noting that it is targeting prime contractor work, which is a major step toward becoming a mid-tier contractor if executed well.

According to a report published by the Ministry of Land, Infrastructure, Transport, and Tourism (MLIT), medium sized construction companies (grouped by amount of invested capital) generated operating margins of almost 3.0% in 2011 and mid 4% in 2015 on average. Taiyo Kisokogyo falls into the same group, but with generally higher margins:

Source: Kenkyo Investing, based on company filings

At least part of the company’s recent business stability comes from a slowly recovering construction investment by the Japanese government. Construction investment in Japan (public and private combined) peaked out in 1992 at 82 trillion yen ($752 billion USD), gradually declined until 2010 to 42 trillion yen ($385 billion USD), and recently recovered to 57 trillion yen ($522 billion USD). With Japan’s aging infrastructure, much of which was built in the 1970s, public construction investment is expected to grow.

Taiyo Kisokogyo owns patent rights to several proprietary construction methods. This isn’t particularly unusual for construction contractors of meaningful size. The worth of the patents will be disregarded for this report as analysis would require considerable domain expertise. Based on Taiyo Kisokogyo’s operating performance, the company appears to run an average to slightly above average quality operating business.

For FY01/21, Taiyo Kisokogyo expects revenues of  15,000 million yen ($137.6 million USD, +26.5%) and operating profits of 675 million yen ($6.2 million USD). Thus far, the company has not made any special announcements regarding the effects of the novel coronavirus on the company’s business.

Shareholders

As of FY01/20 (ending January 31, 2020), Taiyo Kisokogyo had 819,000 shares issued and 154,126 shares in treasury, putting outstanding shares at 665,474. 

Here are the major shareholders:

Source: Kenkyo Investing, based on company filings and Nikkei data

Founder Mitsuru Toyozumi withdrew from management involvement in 2007, but has remained a leading shareholder. One member of the Toyozumi family remains on the board today.

The company offers no equity stock options.

In terms of shareholder returns, the company tends to maintain a dividend payout ratio of about 10 to 20%, which equates to a dividend yield of about 2.4% in FY01/20. Taiyo Kisokogyo periodically performs share repurchases, but on an irregular basis. In December 2019, the company repurchased 10,000 shares (1.5% of outstanding shares) for 65.6 million yen ($600K USD), or a per share price of 6,560 yen. Prior to this, the company conducted meaningful share repurchases in FY01/13 and FY01/15.

Financials & Valuation

  • Taiyo Kisokogyo is a small civil engineering contracting company that is moving toward prime contracts to establish itself as a mid-tier contractor.
  • The company generally maintains healthy operating margins compared to some of its peers of similar size according to reports published by the Japanese government.
  • Moreover, Taiyo Kisokogyo is branching out from its mainstay infrastructure related business, recently extending its services to include renovations and apartment construction work.
  • At 5,430 yen per share, Taiyo Kisokogyo trades at a negative EV with a market capitalization of 3,614 million yen ($33.0 million USD).
  • Investors can expect an investment CAGR of between 11.6% and 15.8%, inclusive of dividends, over three years.

Taiyo Kisokogyo is a small but exceptionally healthy civil engineering contracting company. It’s biggest strength and risk factor is its tight relationship with leading home builder Sekisui House, which accounts for about one-third of annual revenues. Aside from this, the company, like many of its peers, depends on a healthy capital investment and public investment environments.

In terms of balance sheet health, Taiyo Kisokogyo is effectively debt free with a net cash balance sheet. Additionally, the company maintains an equity to asset ratio of 0.69. With some general contractors in the industry suspending operations, however, investors ought to be wary about temporary disruptions in operations for Taiyo Kisokogyo as well. 

Despite the near-term uncertainty in the construction industry, it’s important to note that infrastructure spending is bound to increase, particularly for maintenance spending. Residential demand is certain to affect Taiyo Kisokogyo’s business, however, the company also maintains a sizable infrastructure-related business.

Most importantly, Taiyo Kisokogyo is financially prepared to weather through global financial crisis level hardships. Aside from its generally strong operating margins compared to peers, it’s difficult to gauge any clear competitive advantages the company may have without domain expertise. Based solely on historical margins, the company is likely maintains either an average or slightly above average quality operating business.

At 5,430 yen per share, Taiyo Kisokogyo trades at an EV/EBIT of 0.2x with a market capitalization of 3,614 million yen ($33.0 million USD). Adjusted for long-term investment securities of 1,181 million yen ($10.8 million USD), the company trades at an EV of negative 1,091 million yen ($10.0 million USD). To be sure, the Japanese equity markets were affected by a coronavirus related sell off after the company’s fiscal year end of January 31, 2020. Nevertheless, Taiyo Kisokogyo still trades at negative EV.

Although Taiyo Kisokogyo is both financially and operationally healthy, listed Japanese construction companies tend to trade at low valuations. In fact, with the exception of the last several years, Taiyo Kisokogyo generally traded at negative EV. With this in mind, it’s fair to expect a low fair value EV/EBIT of about 2x.

Assuming a conservative operating profit level of around 300 million yen ($2.7 million USD) over the next several years, the company would generate an investment CAGR of about 15.8%, inclusive of dividends, over three years. If we assume a fair value EV/EBIT of 0, the company would generate an investment CAGR of 11.6%, inclusive of dividends, over three years.

The bottom line

Taiyo Kisokogyo is a healthy and respectable small civil engineering contracting company. The company appears to maintain either an average or slightly above average operations quality coupled with an exceptionally healthy balance sheet. At 5,430 yen per share, investors can expect an investment CAGR of between 11.6% and 15.8%, 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.