My best global stock idea
Summary
Last year Seeking Alpha asked Marketplace authors to post their best idea.
My idea was Sekonic Corp. It worked out well with more than 200% return (in USD).
This year I had a hard time choosing between Man King Holdings and Nepon Inc. I have decided Man King is my best idea for this year. Here is why.
Sekonic Corp revisited
Last year Sekonic Corp was a great investment idea. See my blog article from about a year ago. I thought the stock had little downside because it was so cheap. When I wrote about it it was at 975 JPY. The stock did not move much until 15 November 2021, so there was indeed little downside. Around that time it was announced the stock was going to be acquired by the main shareholders for 3400 JPY. I think the transaction closed at the end of December 2021 or in the beginning of January 2022. See also my update blog on Sekonic. At the end of January 2022 it got delisted.
It was a great pick but of course I was also just lucky it got acquired. That is how quantitative investing works. Many small positions, with many not playing out with good profits but some do give good profits. In the end the average profit is the only thing that matters.
This year: a difficult choice
For this year I have a difficult choice between a very cheap stock that I do not think will be acquired anytime soon and another stock that is more expensive, might have some hidden assets and has higher chances of being acquired.
Nepon Inc
The more expensive stock is Nepon Inc (stock code 7985 in Japan), although it is still very cheap. Nepon Inc (financial statements) manufactures and sells thermal equipment and sanitary equipment, and designs and constructs incidental work associated with these equipment and provides after-sales service. In practice, almost all revenue is from thermal equipment, mostly for agricultural machinery. I think this is heating equipment for greenhouses. The company sells both conventional heating equipment and heat pumps.
The company can be found in Edinet using stock code E02385. Disclosure is in Japanese. My analysis depends on the accuracy and readability of software translations. See the annual report over the year ending on 31 March 2021 and the subsequent quarterly report (30 September 2021).
At 1285 JPY per share the company is cheap based on P/E (=6.3), EV/Revenue and Price/8 years of retained earnings. The company also pays a small dividend. The market cap is very small: 10.8 million USD.
The company is spending lots of money on research and development. During the last 5 reported financial years it spent 2.7 billion JPY on R&D. That is more than twice the market cap! Therefore this company might own substantial intellectual property and know-how. A patent search returns 19 links related to Japanese patents expiring in 10 or more years.
The balance sheet is pretty leveraged, especially for a Japanese company. I do not think this is a big problem since interest rates are extremely low in Japan. I estimate the company pays less than 2% on its debts. Also because the company is profitable I do not see any financial distress here.
Substantial shareholders: Masanobu Higuchi (Chairman of the Nepon Kyoeikai) 6.23%, director or chairman/CEO Fukuda Haruhisa and Fukuda Hiroko 7.23%, Fukuda Gongichi 5.4%, Sato Shoji Co 12.5%, Nepon Mutual Prosperity Association 6.0%, Unitech Co 3.2%.
In November 2021 the company spent 330 million JPY on repurchases for 1375 JPY per share. Red flag: the company repurchased the shares from the Sato Shoji Co. Sato Shoji Co used to be the major shareholder. It is still the largest shareholder but I would not call it a "dominant stake" anymore. I also think Sato Shoji Co lost or will lose control because of this transaction.
It is never a good sign to see the main shareholder selling a profitable decent quality business much below book. It might have been an attempt to satisfy listing requirements though. What I understand from page 18 of the quarterly report (quarter ending 30 September 2021) is the following: one of the listing requirements is a market cap above 1 billion JPY. Though the market cap is well above this minimum the company wanted to make sure it stayed above this minimum. They thought this shareholder friendly buyback would do the trick.
Undervaluation based on earnings, substantial intellectual property and know how, and a selling major shareholder suggest good chances this company is going to be acquired. I do not know when however. In addition, I do not know for what price. That the largest shareholder sold a large block at 1375 JPY does not suggest a high price. However, this is a very small company probably with substantial intangible assets. For such companies large companies often end up paying high prices.
Man King Holdings
The other stock is Man King Holdings (stock code 2193 in Hong Kong). This stock is just extremely cheap based on earnings. I do not think it is going to be acquired. Therefore do not expect a huge return like with Sekonic Corp. BTW, I did not expect a buyout at Sekonic Corp either. The absence of any predictable events is for me another good reason to choose this stock over Nepon Inc as best idea. In any case, I expect it to be a good investment with little downside risk. I have seen returns of up to 150% for other, similarly cheap nanocaps listed in Hong Kong. Such a return would make this stock fairly valued.
Probably that won't be good enough to make it to the top of the list of best ideas from other Marketplace authors. But I do not think that should be my goal as a quantitative investor. And also: about 40% of last year's Marketplace best ideas had a negative return. And more than half of the best ideas underperformed the S&P 500. I think it is unlikely that this happens with this stock. But it is not impossible. For a disappointing return, there needs to be some kind of major event like an invasion of Taiwan.
So, what is Man King Holdings? Man King Holdings (filings) is a nanocap with 128 million HKD of market cap (16.4 million USD) at 0.305 HKD per share. It trades below my conservative estimate of liquidation value. Furthermore it is extremely profitable and has paid out high dividends.
Man King Holdings provides civil engineering services in Hong Kong, for roads and drainage, site formation and port works. Furthermore the company has a 20.3% stake in a "diversified coal transshipment business" (River King Group). This business is about shipping coal to Pakistan. See also the announcement for the purchase of this stake in 2019. Simultaneously with this purchase the spouse of the chairman purchased 70.1% of this coal shipping business.
See the annual report over the year ending on 31 March 2021 and the interim report over the 6 months ending on 30 September 2021.
Last financial year the company received 9.5 million HKD of dividend from the project in Pakistan, in USD. Most profit was the "share of profit from an associate", so 20.3% of the profit of the coal shipping business. However, in the recent interim period most profit was from the construction business.
The company went public in July 2015. The company paid large dividends during last interim period and also in the year ending on 31 March 2019. I have not found any significant dilutions or repurchases.
The 2 executive directors are brothers and controlling shareholders. One of them is the chairman. Therefore, separation between the chairman and CEO role is not optimal. Their sister-in-law is non-independent non-executive director.
Last financial year about half of the revenue was from a single customer. About a third of the revenue was from another customer. Therefore, a risk is that most revenue came from 2 customers.
The balance sheet is strong with low leverage, a high current ratio, lots of cash and some minor current bank debt.
The book value of the current assets is 243 million HKD including about 60 million HKD of not so valuable assets such as contract assets. The book value of the liabilities is 89 million HKD. Among the non-current assets there is 96 million HKD of book value for the coal shipping business. Based on what I read in the annual report I think management can exercise substantial control on this minority owned business. I discount this stake with 50% when estimating the liquidation value. Therefore, my estimate of liquidation value = 243 -0.5*60 -89 +0.5*96 = 172 million HKD and Liquidation Value/Market cap = 172/128 = 1.34.
Substantial shareholders: The 2 brothers, executive chairman Lo Yuen Cheong and executive director Lo Yick Cheong own together 71.55% in a family trust. The chairman also owns 1.12% apart from the trust.
Related party transactions: Last financial year, there were small lease transactions with relatives of the executive directors. Furthermore the company reported small management fee income from the Pakistan project.
Last financial year the chairman earned 4.3 million HKD and his brother earned 3.3 million HKD, both including a modest bonus. The non-independent non-executive director earned 656k HKD including a bonus of 18% of her salary. She gets more than the other non-executive directors. I suppose she gets paid more because she is an accountant advising "the board on internal control and financial management."
Concluding remarks
My best idea for this year is Man King Holdings. Based on several quantitative rankings Man King Holdings is cheaper than Nepon Inc. So this best idea is just based on relentlessly going for the cheapest nanocap. With quantitative investing owning many stocks is usually better than just owning the "best stock". Therefore, I did not choose myself. I own small positions in both stocks.
I think Man King is shareholder friendly having paid dividends. I also think insiders pay themselves too much, considering this is such a small company. If you like a more exiting stock, probably with more upside then you may consider Nepon Inc.