Sakai Heavy Industries: Leader in Niche Market for Road Rollers

Alex Kinmont of Milestone Asset Management updated his outlook for value investing in Japan and presented his investment theses on Sakai Heavy Industries (Japan: 6358), Sankyo Frontier (Japan: 9639), and Nakano (Japan: 1827) at Asian Investing Summit 2019.

Thesis summaries:

Sakai Heavy Industries is a pioneer of road rollers both in Japan and in Asia, founded in 1918 by Kinnosuke Sakai (Japan). They focus on road rollers and tar making machines in Japan and internationally. The two competitive advantages: limited market size (great for smaller businesses, as it deters new entrants), and largest market share. They have the largest share both in Japan and in ASEAN, with a domestic share of 70% and ASEAN share of 40%. The positive aspects of the business outlook: (1) current business environment is supportive for this business, (2) Japan is experiencing an explosion of maintenance and repair demand, (3) NEXCO East, Central, and West has an expressway renewal project targeted between 2014-2030, with the budget for the project approximately JPY 3,000 billion.

The company market value is calculated at JPY 10,900 billion (March 2019), with an EPV per share of JPY 5,717. The market price, as of March 2019, is JPY 2,548, providing a 55% margin of safety.

Sankyo Frontier makes and leases unit houses. Unit houses are used in light construction for multiple uses. A unit house is carried compactly folded, constructed in one day, and originally for construction sites (used to house construction workers during the time of project). They started in narrow markets, and expanded to broader options: shops, restaurants, warehouse, schools, hospitals, etc. The company has one competitor, but has a stronger production capacity, and does direct sales to general constructors (vs using agent sales). Sankyo has a 30% market share.

The stock is at a 60% discount to the theoretical value, with an EPV of 1.5x, EV/EBITDA 3.6x, and PBR of 1.3x. The value of the stock has been at a discounted value for approximately 5 years. The market cap is approximately JPY 28.7 billion. There is JPY 20 billion in unrealized value in their rental asset portfolio. The 10 year old unit houses can be sold at manufacturing costs, not depreciated book value after cleaning. The stock is severely discounted due to the following reasons: (1) conventional steel structured building market is 20x bigger, (2) a massive number of workers are retiring in the construction industry (lack of labor required in its construction technology), and (3) they can sell depreciated rental assets any time, when the user demand is lower.

Nakano is the largest maker of refrigerator showcases for 7-11. The value of the stock stems from the aging Japanese society. A majority of 7-11 clients are over the age of 50, with this segment continuing to grow. This demographic is most likely less employed and single, and therefore creating a stronger market demand for prepared foods.

The company is inexpensive with a “plain” price to book value of 1.2x, and a “plain” EV/EBITDA is 10.8x. The numbers are distorted given that the company has bought back 43.2% of shares, which currently sit in treasury. The numbers reflected on bloomberg/other sites include the treasury shares as if fully issued, which isn’t the case as it is held by the company. Adjusting for the treasury share, the EV/EBITDA is 3.25x. The stock is at a calculated 39% discount.

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About the instructor:

Alexander Kinmont is the CEO of Milestone Asset Management, a Tokyo-based independent asset manager. Milestone offers both long-only and long-short value strategies to institutional investors. It does not employ leverage. Milestone is focused on valuation discrepancies, not just statistically inexpensive stocks. It is guided by a value philosophy which emphasizes minimising the risk of permanent loss of capital. Prior to starting Milestone, Alex headed Japan equity strategy at Morgan Stanley MUFG in Tokyo. He began his career at Daiichi Securities in 1985. Alex graduated from the University of Oxford with a Masters Degree in Literae Humaniores (Latin and Greek Literature and Ancient History) and is fluent in Japanese.