Thinking points
- KFC (TSE: 3420) is a mid-sized construction engineering company specializing in construction materials for public projects such as tunnels and highways. Its revenues are divided into construction fasteners (e.g., anchor bolts), tunneling materials, and construction operations.
- Key challenges for the company include a shortage and aging in its labor forces and the resulting necessity in streamlining and automating its operations.
- Key opportunities include a growing demand in maintenance and renewal of social infrastructure in Japan such as for tunnels and highways, where KFC excels.
- At JPY1,220 per share, KFC trades at an adjusted EV/EBIT of 2.3x with a market capitalization of JPY9.0bn.
- Assuming a fair value EV/EBIT of 2-4x, investors can expect an investment CAGR of -5.7% to +17.0%, including shareholder returns, over the next 3-5 years.
Introduction
KFC (TSE: 3420) is a mid-sized construction engineering company, specializing in development, sales and installation of construction materials such as anchor bolts. The company operates mainly for public projects such as highways and tunnels, commanding strong domestic market shares in rock bolts and impervious sheets. Since FY03/2012 it has been operating under three segments:
- Construction Fastener: Sales of post-installed anchors, or anchor bolts that are installed into hardened concrete structures;
- Construction Materials: Sales of materials mainly for tunnel construction;
- Construction Operations: Design and operation of projects such as interior and renewal works of tunnels and highways.
Business & operating environment
Company History
KFC was originally founded in 1965 as Kensetsu Fastener Company (Construction Fastener Company) in Tokyo, to sell construction anchors and fasteners. Since then, the company expanded its operations throughout the country driven by rapid construction demand under the Japanese economic miracle (~1973). In 1986, the company was renamed to the current KFC. In 1997, KFC listed its shares on the Second Section of the Osaka Stock Exchange, which has been restructured into the Standard Section of the Tokyo Stock Exchange now. Throughout its history, KFC has been a pioneer of the New Austrian Tunneling Method (NATM) in Japan.
Industry and Business Model
As mentioned above, KFC specializes in construction materials for tunnel works, which falls under the civil engineering industry. In 2021, the Japanese civil engineering market stood at JPY17.7tn, broken down into JPY13.4tn for public projects (75%) and JPY4.3tn for private projects (25%). Tunnel construction is classified as public works, with a market size of JPY0.8tn (5% of the civil engineering industry).
One of the issues related to civil engineering in Japan is the accelerated aging of social infrastructure that was built during the Japanese economic miracle, including road bridges, tunnels, rivers, sewers, and ports. For tunnels, over 20% of existing facilities are more than 50 years old, and this figure will rise to 42% in 10 years. The need for renewal and maintenance of old social infrastructure is now seen as an urgent social issue, especially following the Sasago Tunnel collapse in 2012. During the tragedy, 9 people were killed and 2 were injured after a concrete slab of the ceiling collapsed over a distance of 138 meters in the Sasago Tunnel of the Chuo Expressway, which was 35 years old at that time.
Percentage of Social Infrastructure 50yr+ Old
According to the Ministry of Land, Infrastructure, Transport and Tourism of Japan, the expenditure for social infrastructure maintenance and renewal will reach JPY10.9-12.3tn per year in 2048, rising from JPY5.2tn in 2018 (2.5-2.9% CAGR). This can be seen as a tailwind for KFC, which generates most of its revenue from public construction.
KFC’s business performance fluctuates in line with the volume of public works orders, mainly in the construction operation segment. On the other hand, sales of construction fasteners and other materials have historically been stable.
For the recent couple of years, KFC’s revenues have been falling due to delays in construction schedules following the COVID-19 pandemic, rising construction material prices, and chronic staff shortages.
As for operating profit, KFC maintained a +4.0% margin even in FY03/13, when sales fell substantially. After streamlining operations, its operating margin in FY03/15-FY03/22 stabilized around 10%. However, the company will likely not be able to absorb the drop in revenue in FY03/23, and projects a drop in operating profit margin to the 4% level.
Shareholders
As of the end of September 2022, the company had 7,378,500 shares issued, with no shares in treasury. Foreign shareholders accounted for approximately 5.3% of total. Major shareholders are as follows.
Nobuko and Shunta Takada are part of the founding family.
Sekisui Jushi, Denka and Nasu Denki are chemical and construction material manufacturers that are also KFC’s suppliers. MST is an insurance agency under the MUFG umbrella, the largest financial group in Japan.
KFC aims to maintain a shareholder payout ratio of over 30%. As the company has not performed any share repurchases in recent years, dividends are tied to earnings projections. KFC has raised its payout ratio from 16% in FY03/17 to 28.0% in FY03/22. For FY03/23, the company initially guided for a payout ratio of 27.1% against a net income of JPY1.9bn. However, it downwardly revised its forecast in November 2022, lowering net income projections to JPY0.75bn and dividend per share from JPY70 to JPY40 for a payout ratio of 39.2%.
Financials & valuation
- KFC (TSE: 3420) is a mid-sized construction engineering company specializing in construction materials for public projects such as tunnels and highways. Its revenues are divided into construction fasteners (e.g., anchor bolts), tunneling materials, and construction operations.
- Key challenges for the company include a shortage and aging in its labor forces and the resulting necessity in streamlining and automating its operations.
- Key opportunities include a growing demand in maintenance and renewal of social infrastructure in Japan such as for tunnels and highways, where KFC excels.
- At JPY1,220 per share, KFC trades at an adjusted EV/EBIT of 2.3x with a market capitalization of JPY9.0bn.
- Assuming a fair value EV/EBIT of 2-4x, investors can expect an investment CAGR of -5.7% to +17.0%, including shareholder returns, over the next 3-5 years.
In terms of its balance sheet, KFC is operating virtually debt-free. It had JPY0.7bn in borrowings as of September 2022, while holding JPY4.1bn in cash and deposits. Its liquidity ratio and equity ratio were at 253% and 73%, respectively.
Some of the challenges the company faces include a labor shortage and aging in the Japanese construction industry, and a resulting risk of a contraction in orders. According to the MLIT, the labor force has been decreasing from 6.85mn people in 1997 to 4.82mn people in 2021 (-1.5% CAGR), and 35.5% of the labor force is above 55 years old. This is higher than the all-industry average of 31.2%. Unless KFC can continue to recruit young talent or trim down labor by automating operations, it may not be able to maintain or grow order volumes in the future.
In terms of opportunities, large-scale public projects are expected to continue being awarded for the foreseeable future to maintain and renew Japan’s aging social infrastructure, which should serve as a tailwind for KFC.
At JPY1,220 per share, KFC trades at an adjusted EV/EBIT of 2.3x with a market capitalization of JPY9.0bn. Assuming a fair value EV/EBIT of 2-4x, a payout-ratio to net income of 30%, and earnings as low as FY2022 projection for pessimistic scenario and as high as FY2021 for optimistic scenario, investors can expect an investment CAGR of between -5.7% and +17.0%, including shareholder returns, over the next 3 to 5 years.
The bottom line
KFC is a mid-sized construction engineering company specializing in materials such as anchor bolts, rock bolts and impervious sheets mainly installed for tunnels and highways. Although the company faces some challenges such as a shortage and aging in its labor force and the resulting need to streamline and automate operations, it also has tailwinds such as a growing demand in social infrastructure maintenance and renewal. Buying in at JPY1,220 per share, investors can expect an investment CAGR of between -5.7% and +17.0%, including shareholder returns, over the next 3 to 5 years.
