Thinking points

  • Kikukawa Enterprise (TSE: 6346) manufactures industrial machinery with a focus on lumber and woodworking machinery, holding the top share for both in the Japanese market. In addition, the company also manufactures polarizing film edge shapers for LCDs, printed circuit board cutting and finishing machines, and NC processing machines.
  • In recent years, the company has managed to secure recurring profits, but sales have been volatile. One key challenge going forward is whether the company can effectively utilize its excess cash reserves (70%+ of total assets) as the downstream housing market shrinks.
  • With business trends such as the shift toward a sustainable society and growing interest in effectively using domestic forest resources, there is a good possibility the company will be able to expand its Woodworking segment.
  • At JPY4,200 per share, Kikukawa Enterprises trades at 67% P/NCAV and a negative enterprise value with a market capitalization of JPY55.0bn.
  • Assuming a fair value P/NCAV of 100~120%, investors can expect an investment CAGR of between 7.9% and 16.5% over the next 5 to 8 years.

Introduction

Kikukawa Enterprises (TSE: 6346) is an industry machinery manufacturer with a focus on lumber and woodworking machinery. With its cutting and polishing technologies, the company holds the top share of the Japanese market for lumber and woodworking machinery. In addition, it also manufactures polarizing film edge shapers for LCDs, printed circuit board cutting and finishing machines, and NC processing machines.

Kikukawa operates through two segments: Woodworking and Machine Tools.

Source: Kenkyo Investing, based on company data

Business and operating environment

Kikukawa had been manufacturing carpenter’s tools and Japanese nails for the shipbuilding industry since the end of the Edo period. After being established as a corporation in 1897, it obtained a patent for the friction feed automatic circular saw, the first sawmill in Japan, and began manufacturing and selling it. The company then developed Japan’s first woodworking machine in 1904. In 1964, the company listed on the Second Section of the Osaka and Nagoya Stock Exchanges. In 1979, the company began manufacturing printed circuit board (PCB) processing machinery, and in the 1990s, it began expanding outside of the lumber and woodworking industries, developing model processing machines for automobiles, machining centers for railway wagons, and various machining centers for aircrafts. In 2012, the company built its current core plant in Ise City. The founding Kikukawa family has led the company for generations and Atsushi Kikukawa, who became president in 1997, is the sixth generation president.

Source: Kenkyo Investing, based on company data

The Woodworking segment is broadly divided into sawmill machinery and woodworking machinery, with the former developing, manufacturing, and selling machinery for cutting raw lumber into square lumber, plywood, and laminated wood, and the latter developing, manufacturing, and selling machinery for pre-cutting, hogging, and grooving lumber according to its intended use. The company is a pioneer in the lumber and woodworking machinery industry in Japan and the largest manufacturer in the country. Its main customers are sawmills and lumber mills, and the company’s sales closely follow trends in the housing market since most of its products are used to process building materials.

The Machine Tools segment expands outside lumber and woodworking machinery and develops, manufactures, and sells printed circuit board (PCB) cutting and finishing machines, polarizing film edge shapers for LCDs, and molded model and body processing machines for automobiles, trains, and aircraft.

The Woodworking segment accounts for roughly 60% and the Machine Tools segment accounts for about 40% of sales, but orders and sales are volatile as both segments sell high-priced items.

The global market size for sawmill and woodworking machinery (2020) is USD4.2bn, with the US and China accounting for roughly half of the global market at USD1.1bn and USD0.9bn, respectively. The Japanese market was estimated at JPY26bn (USD240mn) in 2019, with Kikukawa holding about 10% of the market. The market is projected to grow at a CAGR of 1.7% from 2020-2027, headed by China’s growth at 3.4% CAGR. The Japanese market is expected to grow at a 0.2% CAGR, sustaining current levels despite the decline in housing starts. However, a June 2020 report by Nomura Research Institute projects that while renovation demand will continue to trend slightly upward, new housing starts will be halved by 2040 due to a declining population.

*1 Sum of “Woodworking machinery and sawmill machinery” and “Veneer and plywood machinery”
*2 Woodworking segment
Source: Kenkyo Investing, based on Ministry of Economy, Trade and Industry

Kikukawa began horizontal expansion of its business in the 1980s, and started manufacturing machinery for processing non-wood materials by leveraging its cutting and polishing technologies. In addition to the automobile, rail, aircraft, and semiconductor industries which the company has historically served, Kikukawa has also worked to build its business in polarizing film edge shapers  for LCDs used in smartphones. The Machine Tools segment has grown and is now comparable to the Woodworking segment in terms of sales contribution.

The company’s performance is relatively volatile. Following the global financial crisis and the European debt crisis, the company posted recurring losses due to sluggish overseas sales volume. Subsequently, the company lowered fixed costs, reducing its employee count by 22% from 240 at end-FY03/08 to 187 at end-FY03/14, and recurring profit margins have since fared steadily between 12-15%.

In FY03/19, the company posted record profits after securing large orders both in Japan and overseas. Orders fell in FY03/21 owing to the COVID-19 pandemic, but the company still expects to secure a recurring profit margin of around 15%. Profit margin by segment is not disclosed.

Overseas sales generally accounts for 30% of total sales, but in the Machine Tools segment, the overseas sales ratio carries greater weight at around 50%.

Shareholders

As of end-September 2020, the company had 1,320,000 shares issued and 44,500 shares in treasury, putting outstanding shares at 1,275,500.

Source: Kenkyo Investing, based on company data

There have been no major changes in the composition of major shareholders, with the founding family and treasury shares accounting for about 15% of shares. The largest shareholder is an individual whose details are unknown, but is also the largest shareholder of Taihei Machinery Works (TSE: 6342). Trust Account E is a trust asset of the Employee Incentive Plan, which is a type of stock option. Hyakugo Bank (TSE: 8368) is the first regional bank in Mie Prefecture, where Kikukawa is headquartered, and slightly reduced its holdings in FY03/21.

The company’s dividend payout ratio is generally around 10 to 20%, and it has suspended dividends when posting recurring losses in the past. In May 2018, the company announced a share buyback and acquired subsequently repurchased 200,000 shares. There are no stock options outstanding.

Financials and valuation

  • Kikukawa Enterprises manufactures industrial machinery with a focus on lumber and woodworking machinery, holding the top share for both in the Japanese market. In addition, the company also manufactures polarizing film edge shapers for LCDs, printed circuit board cutting and finishing machines, and NC processing machines.
  • In recent years, the company has managed to secure recurring profits, but sales have been volatile. One key challenge going forward is whether the company can effectively utilize its excess cash reserves (70%+ of total assets) as the downstream housing market shrinks.
  • With business trends such as the shift toward a sustainable society and growing interest in effectively using domestic forest resources, there is a good possibility the company will be able to expand its Woodworking segment.
  • At JPY4,200 per share, Kikukawa Enterprises trades at 67% P/NCAV and a negative enterprise value with a market capitalization of JPY55.0bn.
  • Assuming a fair value P/NCAV of 100~120%, investors can expect an investment CAGR of between 7.9% and 16.5% over the next 5 to 8 years.

Kikukawa Enterprise is an industrial machinery manufacturer with a focus on lumber and woodworking machinery, and runs a debt-free operation.

Some of the challenges Kikukawa faces includes a shrinking construction material market and housing market. With the number of new construction starts in the housing market on a downward trend owing to the decline in the Japanese population, the outlook for capital spending by material suppliers is not promising. In addition, for its overseas business, intensifying competition due to technological advances by competitors in Asia and elsewhere, and the obsolescence of Kikukawa’s technology are risk factors.

As for future opportunities, the effective use of forest resources, which account for two-thirds of Japan’s land area, and wooden buildings are increasingly attracting interest with support for the Sustainable Development Goals (SDGs) and the expansion of ESG investment. If KIKUKAWA is recognized as an ESG-related company, it may be included in a related index.

Source: Kenkyo Investing, based on company data

Of the JPY12bn in total assets, the company is cash-rich with JPY7bn in cash and deposits and an extremely high current ratio of 890%. Of this amount, JPY3.7bn is in time deposits, and in March 2021, Unearth International, a major shareholder (an independent activist), submitted a request for the company to reduce the balance of cash and deposits by JPY3bn yen through dividends and business investment. In addition, JPY891mn in long-term investment securities is mostly in cross-shareholdings of trade partners. In terms of liabilities, the company has no debt and an equity-to-asset ratio of 85%, which is one factor behind its stagnant ROE of around 4%.

As of end-March 2021, Kikukawa shares traded around JPY4,200 with a market capitalization of about JPY5.5bn. In contrast, the company’s net current assets were at JPY7.3bn. Adjusting in long-term investment securities, this figure rises to JPY8.2bn, giving Kikukawa a P/NCAV valuation of 67%. Additionally, on an adjusted basis, the company trades at negative EV.  Assuming a fair value P/NCAV of 100-120%, investors can expect an investment CAGR of between 7.9 and 16.5%, including shareholder returns, over the next 5 to 8 years.

The bottom line

Kikukawa Enterprises is a leading manufacturer of lumber and woodworking machinery in the Japanese market. Although the company faces challenges such as a shrinking Japanese housing market, it also has tailwinds like Japan’s push to boost usage of its abundant forest resources. Buying in at JPY4,200 per share, investors can expect an investment CAGR of between 7.9% and 16.5% over the next 5 to 8 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.