Thinking points

  • Wavelock Holdings Co., Ltd. (TSE: 7940) is a chemical product manufacturer specializing in industrial and agricultural materials, holding the top market share in the Japanese insect screen market. The company withdrew from its Interior business in FY03/21 to focus on its remaining three segments.
  • Key challenges include a lack of crude oil-based raw materials and addressing ESG demands of stakeholders.
  • Key opportunities include the company’s solid expertise in plastic processing cultivated over more than half a century, and a shift in trend in the car exterior industry from plating/painting to metallic decorative films, which Wavelock sells.
  • At JPY725 per share, Wavelock trades at an adjusted P/NCAV of 110.4% with a market capitalization of JPY7.1bn, after taking into account the sale of its Interior business.
  • Assuming a fair value P/NCAV of 80~120%, investors can expect an investment CAGR of between -1.4% and +6.2%, including shareholder returns, over the next 5 to 8 years.

Introduction

Wavelock Holdings is a chemical product manufacturer specializing in industrial and agricultural materials, holding the top share in the Japanese insect screen market. Wavelock reports through three segments: Material Solutions, Advanced Technology, and Other.  The Interior segment was terminated at the end of FY03/21 as a result of its sale to former business partner Sangetsu.

Source: Kenkyo Investing, based on company data

Business & operating environment

Company History

Wavelock was established in 1964 as a joint venture between a Japanese trading company and two chemical product manufacturers with the aim of introducing the Wavelock patent, an Italian resin processing technology, to Japan. After listing on the Second Section of the Tokyo Stock Exchange in 1996, the company continued to grow through M&A. However, with raw material prices soaring (mainly naphtha) along with a deterioration in the company’s negotiating position, Wavelock underwent an MBO and was delisted in 2009. The aim was to establish a sustainable business structure, and it was during this time that the company formed a partnership with Sangetsu, Japan’s leading trading company specializing in interior products. Wavelock entered the interior business and Sangetsu acquired 22.2% of Wavelock’s shares before relisting its shares on the Tokyo Stock Exchange in April 2017.  In 2021, however, the company effectively withdrew from the interior business by transferring a majority stake in its interior subsidiary to Sangetsu. The two companies subsequently dissolved the alliance and Sangetsu plans to sell its stake in Wavelock.

Industry and Business Model

Wavelock’s performance is substantially influenced by the price of Naphtha, one of its main raw materials. Naphtha prices generally trend in line with that of crude oil, and hovered high in the late 2010’s as illustrated in the chart below. In 2020, it plummeted for a while, reflecting the drop in oil-demand after the spread of COVID-19, but has since skyrocketed after economic activities resumed in 2021. The surge in raw material prices pressures operating profits for Wavelock as it is not always able to pass the costs onto its customers.

Source: Kenkyo Investing, based on Investing.com

Wavelock’s business model has traditionally relied on processed plastic products for industries such as agriculture, construction, and automobiles. Domestic demand for high-performance plastic materials for construction and automobiles has been firm over the last couple of decades, but demand for agricultural materials has been trending downward (the figure below shows the plastic sales index for each industry in Japan).

In light of these headwinds, the company decided to expand into new businesses. According to its medium-term plan spanning FY03/22 to FY03/24, Wavelock aims to expand into the geothermal materials business, address ESG demands by producing environment-friendly food packaging and construction materials, and expand its sales channels for agricultural materials into China, Korea, and Vietnam.

Source: Kenkyo Investing, based on The Japan Plastic Federation

Wavelock has been growing steadily in each segment from pre-MBO to FY03/20. In terms of sales-CAGR (FY2012-2021), Material Solution and Interior grew at +0.6% and +2.8% respectively, while Advanced Technology grew at +9.5% over the last decade. Although the Interior segment generated higher operating margins compared to the Material Solution segment, Wavelock decided to sell the Interior business to focus its resources on the Advanced Technology segment, which has better growth prospects. For FY03/22, the company forecasts sales of JPY20.4bn and operating profit of JPY750mn.

Source: Kenkyo Investing, based on company data

Source: Kenkyo Investing, based on company data

Shareholders

As of end-September 2021, the company had 11,120,538 shares issued and 1,284,500 shares in treasury, putting outstanding shares at 9,836,038.

Source: Kenkyo Investing, based on company data

As of the end of September 2021, Sangetsu was still the largest shareholder but has already expressed its intention to sell its stake. Mr. Kinebuchi and Mr. Fukuda are both the company’s former executives. RE FUND 107-CLIENT AC is registered at the same address as Kuwait Investment Authority, Kuwait’s largest sovereign wealth fund, but details are unknown. Japan Securities Finance is the only securities finance operator in Japan.  The others are custodians with no details about the underlying investors.

Previously, the company targeted a payout ratio of 20-30% net of negative goodwill amortization, but it has raised its target to a minimum of 35% since FY03/22. In October 2021, Wavelock announced its largest ever share repurchase of up to 1.5mn shares, or 15.3% of its outstanding shares. The company also conducted share repurchases in 2018 and 2019. There are no existing stock acquisition rights.

Financials & valuation

  • Wavelock Holdings Co., Ltd. is a chemical product manufacturer specializing in industrial and agricultural materials, holding the top market share in the Japanese insect screen market. The company withdrew from its Interior business in FY03/21 to focus on its remaining three segments.
  • Key challenges include a lack of crude oil-based raw materials and addressing ESG demands of stakeholders.
  • Key opportunities include the company’s solid expertise in plastic processing cultivated over more than half a century, and a shift in trend in the car exterior industry from plating/painting to metallic decorative films, which Wavelock sells.
  • At JPY725 per share, Wavelock trades at an adjusted P/NCAV of 110.4% with a market capitalization of JPY7.1bn, after taking into account the sale of its Interior business.
  • Assuming a fair value P/NCAV of 80~120%, investors can expect an investment CAGR of between -1.4% and +6.2%, including shareholder returns, over the next 5 to 8 years.

Wavelock is a chemical products manufacturer with the largest domestic share in insect screens. It also develops and sells advanced materials such as metallic decorative films. In FY03/21, the company sold its Interior business to its major shareholder, Sangetsu, in order to streamline its balance sheet and focus its management resources. The company’s operating profit margins have been fluctuating between +0.8% and +6.6% for the past 10 years, partly affected by volatility in raw material prices.

The challenges Wavelock faces include the need to reduce its dependence on raw materials derived from soaring crude oil prices and addressing ESG issues. In terms of the former, as a medium-sized manufacturer, Wavelock is not positioned to pass on prices downstream in the supply chain, and hedging price fluctuations with derivatives does not offer a structural solution. Therefore, there is an urgent need to diversify its product portfolio. As for the latter, as ESG criteria have become more common when evaluating stocks, business partners may avoid naphtha-derived products as a result of increasing sophistication in carbon traceability, and investors may think twice before holding Wavelock shares. As such, there is also an urgent need to start switching to ESG-conscious raw materials such as bioplastics and to develop environmentally friendly solutions.

In terms of opportunities, the company has an edge in plastic processing technology built on over half a century of experience, and is well positioned to meet the growing need for functional agricultural materials in Southeast Asia and other emerging countries. In addition, as the automotive industry moves away from plating and painting owing to environmental concerns, the company’s metallic decorative films are coming into play as a competitive alternative.

As of end-September 2021, Wavelock is effectively debt-free, with interest-bearing debt of JPY3.8bn against cash and deposits of JPY4.1bn. Taking into consideration its equity ratio of 60% as well, the company has a solid financial footing.

At JPY725 per share, Wavelock currently trades at an adjusted P/NCAV of 110% with a market capitalization of JPY7.1bn, after taking into account the sale of its Interior business. Assuming a fair value P/NCAV ratio of 80% to 120%, investors can expect an investment CAGR of between -1.4% and +6.2%, including shareholder returns, over the next 5 to 8 years.

The bottom line

Wavelock Holdings Co., Ltd. is a chemical product manufacturer commanding the largest share of the Japanese insect screen market. Although the company faces some challenges such as volatile raw material prices and pressure to meet ESG demands, it also has tailwinds such as its well-honed technology in plastic processing and the rising demand in its metallic decorative films. Buying in at JPY725 per share, investors can expect an investment CAGR of between -1.4% and +6.2%, including shareholder returns, 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.