Thinking points
- Sakura KCS (TSE: 4761) is a system integrator affiliated with Sumitomo Mitsui Financial Group, offering general IT services such as IT infrastructure and network construction, operations, and maintenance, as well as BPO services to the financial, industrial, and public sectors.
- Key challenges for the company include the continuous retention, recruitment and training of IT personnel necessary for meeting client requirements amid a looming severe IT staffing shortage.
- Key opportunities include the stable corporate earnings underpinned by parent and affiliated companies and strong IT infrastructure investment demand driven by corporate digital transformation initiatives.
- At JPY800 per share, Sakura KCS trades at an adjusted P/NCAV of 68%, with a market capitalization of JPY9.0bn
- Assuming a fair value P/NCAV of 80-120%, investors can expect an investment CAGR of +3.1% to +13.0% including shareholder returns, over the next 5-8 years.
Introduction
Sakura KCS (SKCS) is a small system integrator affiliated with the Sumitomo Mitsui Finacial Group. Its business segments are categorized into the financial, public, and industrial sectors. Each segment consists of the same functions:
- System construction such as contract development of software or sales of packaged software;
- System operation and maintenance, including for cloud services, BPO services, IDC services (housing and hosting), and outsourcing business; and
- Design and building of IT infrastructure or network environments.
Business & operating environment
Company History
Sakura KCS, which started out as Kobe Computer Service, launched operations in 1969 in Kobe City. In 1971, it received investment from Kobe bank (now SMBC) and Fujitsu. After pursuing several M&A opportunities involving local system integrators in the 1970-80s, the company changed its name to KCS in 1988, then to Sakura KCS in 1992 to coincide with the launch of Sakura bank. In 2000, Sakura KCS was listed on the second section of the Osaka Stock Exchange.
Industry and Business Model
Sakura KCS provides comprehensive services to serve its clients’ IT needs, ranging from system planning and construction to system operations and management, as well as system equipment sales.
According to IDC Japan’s estimates in June 2022, the domestic IT infrastructure market amounted to JPY1.76tn in 2021, and is expected to grow at a 3.2% CAGR to JPY2.05tn in 2026. The development sector (CAGR +2.5%) will be driven by the acceleration of remote work and digital transformation initiatives, while the operation and maintenance sector (CAGR +3.3%) will continue to be driven by demand for cloud computing, Virtual Desktop Infrastructure, and Desktop as a Service (DaaS).
Recovery has been slow in the distribution, manufacturing, and tourism industries due to supply chain disruptions, but IT investment is beginning to normalize. In the financial and industrial sectors, where SKCS excels, growth is expected to continue as before. In particular, the company’s core financial IT systems market has been growing steadily on the back of Digital Transformation initiatives and is expected to grow 1.1% YoY to JPY2.5tn in 2022.
In terms of segment sales, KCS saw sales grow mainly in the financial sector up until FY03/16, after which its IT construction for financial institutions and public sectors slowed down. Then, from FY03/20 onward, sales to the industrial and public sectors returned on a growth trajectory, marking a 10 year CAGR of 1.7%.
For FY03/23, the company expects a slight drop in sales owing to the end of BPO operations for the SMBC Group and the end of large-lot system development projects for major vendors. However, SMBC commenced development of a new accounting system with a project budget of JPY50bn, some of which will likely be awarded to Sakura KCS.
Shareholders now account for about one-third of sales, with Fujitsu accounting for 18% and Sumitomo Mitsui Financial Group accounting for 17%. Sales mix from affiliate companies has grown from 21.5% in FY03/11 to 34.7% in FY03/22.
Much like its sales performance, the company’s OPM has been recovering since FY03/20, which is still low at 3.3%. SKCS has been routinely acquiring unprofitable projects as it prioritized securing orders, and is now restructuring its business portfolio. The company’s ROE has also been stagnant at 3~4% owing to its low margin and leverage.
Shareholders
As of the end of September 2021, the company had 11,200,000 shares issued and 700 shares in treasury, putting outstanding shares at 11,199,300. Foreign shareholders accounted for approximately 0.9% of total. Major shareholders are as follows.
Sumitomo Mitsui Banking Corporation (SMBC) is under the Sumitomo Mitsui Financial Group (SMFG) and one of the largest merchant banks in Japan. Sumitomo Mitsui Finance and Leasing Company and SMBC Consulting are SMFG’s general leasing and consulting arms. Currently, four out of Sakura KCS’s seven directors, including the CEO, come from SMBC.
Fujitsu Japan is a system integrator under the Fujitsu group. Nippon Life is the largest life insurer in Japan.
Minato Bank (a local bank), Glory (the world’s largest manufacturer of money-handling machines), and Hyogo Toyota (a car dealer) are all headquartered in the same area as SKCS.
There has been no stock option, or share buybacks over the past 5 years.
Financials & valuation
- Sakura KCS (TSE: 4761) is a system integrator affiliated with Sumitomo Mitsui Financial Group, offering general IT services such as IT infrastructure and network construction, operations, and maintenance, as well as BPO services to the financial, industrial, and public sectors.
- Key challenges for the company include the continuous retention, recruitment and training of IT personnel necessary for meeting client requirements amid a looming severe IT staffing shortage.
- Key opportunities include the stable corporate earnings underpinned by parent and affiliated companies and strong IT infrastructure investment demand driven by corporate digital transformation initiatives.
- At JPY800 per share, Sakura KCS trades at an adjusted P/NCAV of 68%, with a market capitalization of JPY9.0bn
- Assuming a fair value P/NCAV of 80-120%, investors can expect an investment CAGR of +3.1% to +13.0% including shareholder returns, over the next 5-8 years.
On the back of the relatively stable demand for its service, particularly from affiliated companies, SKCS has been operating completely debt-free for years (excluding capital lease obligations). This has resulted in the company’s high equity ratio of 77.8%. As of September 2022, SKCS holds JPY7.4bn in cash, compared to total assets of JPY21.4bn.
Some challenges the company faces include ongoing IT staffing and on-the-job training costs. According to a study by Mizuho Research & Technologies in 2018, commissioned by the METI (Ministry of Economy, Trade and Industry of Japan), there will be a shortage of 790,000 IT personnel in Japan by 2030. SKCS’s system construction and IT infrastructure construction services are still labor-intensive, and the company will need to continuously retain and enhance its human capital to expand its business going forward.
In terms of opportunities, the company expects to take advantage of the growing IT infrastructure market to build a strong customer base and offer competitive products.
At JPY800 per share, Sakura KCS trades at an adjusted NCAV of JPY 13.2bn with a market capitalization of JPY9.0bn. Assuming a fair value P/NCAV of 80-120% and a shareholder payout ratio of approximately 20% in line with recent trends, investors can expect an investment CAGR of between +3.1% and +13.0%, including shareholder returns, over the next 5 to 8 years.
The bottom line
Sakura KCS (SKCS) is a small system integrator under the Sumitomo Mitsui Financial Group, with one third of its revenues coming from parent and affiliated companies. It offers system construction and IT infrastructure development services, while also selling packaged software. Although the company faces some challenges such as the lack of IT personnel needed for business growth, it also has tailwinds such as the strong demand for IT infrastructure underpinned by corporate investment in digital transformation initiatives, as well as medium-term orders for large projects from parent company SMBC. Buying in at JPY800 per share, investors can expect an investment CAGR of between +3.1% and +13.0%, including shareholder returns, over the next 5 to 8 years.
